Stock Analysis

Zheneng Jinjiang Environment Holding (SGX:BWM) Use Of Debt Could Be Considered Risky

Source: Shutterstock

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Zheneng Jinjiang Environment Holding Company Limited (SGX:BWM) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Zheneng Jinjiang Environment Holding

What Is Zheneng Jinjiang Environment Holding's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2022 Zheneng Jinjiang Environment Holding had debt of CN¥11.2b, up from CN¥10.5b in one year. However, because it has a cash reserve of CN¥627.0m, its net debt is less, at about CN¥10.6b.

SGX:BWM Debt to Equity History March 24th 2023

A Look At Zheneng Jinjiang Environment Holding's Liabilities

According to the last reported balance sheet, Zheneng Jinjiang Environment Holding had liabilities of CN¥7.17b due within 12 months, and liabilities of CN¥7.43b due beyond 12 months. Offsetting these obligations, it had cash of CN¥627.0m as well as receivables valued at CN¥3.11b due within 12 months. 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¥1.50b 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 measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 2.4 times and a disturbingly high net debt to EBITDA ratio of 7.1 hit our confidence in Zheneng Jinjiang Environment Holding like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. On a slightly more positive note, Zheneng Jinjiang Environment Holding grew its EBIT at 12% over the last year, further increasing its ability to manage 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Zheneng Jinjiang Environment Holding burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Zheneng Jinjiang Environment Holding's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. Taking into account all the aforementioned factors, it looks like Zheneng Jinjiang Environment Holding has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Zheneng Jinjiang Environment Holding has 3 warning signs we think you should be aware of.

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.

Valuation is complex, but we're helping make it simple.

Find out whether Zheneng Jinjiang Environment Holding is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis