These 4 Measures Indicate That Zheneng Jinjiang Environment Holding (SGX:BWM) Is Using Debt Extensively

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Zheneng Jinjiang Environment Holding Company Limited (SGX:BWM) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Zheneng Jinjiang Environment Holding

How Much Debt Does Zheneng Jinjiang Environment Holding Carry?

As you can see below, at the end of September 2022, Zheneng Jinjiang Environment Holding had CN¥11.0b of debt, up from CN¥10.6b a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is Zheneng Jinjiang Environment Holding's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zheneng Jinjiang Environment Holding had liabilities of CN¥7.23b due within 12 months and liabilities of CN¥7.10b due beyond that. On the other hand, it had cash of CN¥200.1m and CN¥3.28b worth of receivables due within a year. So its liabilities total CN¥10.9b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥1.51b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Zheneng Jinjiang Environment Holding would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Zheneng Jinjiang Environment Holding has a rather high debt to EBITDA ratio of 7.3 which suggests a meaningful debt load. However, its interest coverage of 2.6 is reasonably strong, which is a good sign. Looking on the bright side, Zheneng Jinjiang Environment Holding boosted its EBIT by a silky 49% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Zheneng Jinjiang Environment Holding's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Zheneng Jinjiang Environment Holding burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Zheneng Jinjiang Environment Holding's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Zheneng Jinjiang Environment Holding to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Zheneng Jinjiang Environment Holding (including 2 which are significant) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.