China’s environmental energy investment (HKG:986) appears to be using debt quite wisely
David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that China Environmental Energy Investment Limited (HKG:986) uses debt in his business. But the more important question is: what risk does this debt create?
What risk does debt carry?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
Check out our latest analysis on environmental energy investment in China
What is the net debt of China Environmental Energy Investment?
You can click on the graph below for historical figures, but it shows that China Environmental Energy Investment had HK$17.3 million in debt in September 2021, up from HK$26.1 million a year earlier. But on the other hand, he also has HK$50.1 million in cash, resulting in a net cash position of HK$32.8 million.
A look at the liabilities of China Environmental Energy Investment
Zooming in on the latest balance sheet data, we can see that China Environmental Energy Investment had liabilities of HK$24.3 million due within 12 months and liabilities of HK$18.2 million due beyond. On the other hand, it had cash of HK$50.1 million and HK$142.0 million of receivables due within one year. He can therefore boast that he has HK$149.6 million more in liquid assets than total Passives.
This abundant liquidity means that China Environmental Energy Investment’s balance sheet is as strong as a giant redwood. Given this fact, we believe its balance sheet is as strong as an ox. Simply put, the fact that China Environmental Energy Investment has more cash than debt is arguably a good indication that it can safely manage its debt.
Although China Environmental Energy Investment had a loss in EBIT last year, it was also good to see that it generated HK$13 million in EBIT in the last twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But it is the profits of China Environmental Energy Investment that will influence the balance sheet in the future. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.
Finally, a company can only repay its debts with cash, not book profits. Although China Environmental Energy Investment has net cash on its balance sheet, it is still worth looking at its ability to convert earnings before interest and taxes (EBIT) to free cash flow, to help us understand how quickly it builds (or erodes) this cash balance. Over the past year, China Environmental Energy Investment has burned a lot of money. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.
While it is always a good idea to investigate a company’s debt, in this case, China Environmental Energy Investment has HK$32.8 million in net cash and a strong balance sheet. So we have no problem with the use of debt by China Environmental Energy Investment. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. To do this, you need to find out about the 4 warning signs we spotted with China Environmental Energy Investment (including 1 that should not be overlooked).
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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