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. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, China Suntien Green Energy Corporation Limited (HKG:956) is in debt. But does this debt worry shareholders?
When is debt dangerous?
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. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. 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. The first thing to do when considering how much debt a business has is to look at its cash and debt together.
Check out our latest analysis for China Suntien Green Energy
What is China Suntien Green Energy’s net debt?
As you can see below, at the end of March 2022, China Suntien Green Energy had a debt of 36.4 billion Canadian yen, compared to 32.7 billion yen a year ago. Click on the image for more details. However, he has 5.92 billion Canadian yen in cash to offset this, resulting in a net debt of approximately 30.5 billion Canadian yen.
A look at the liabilities of China Suntien Green Energy
According to the latest published balance sheet, China Suntien Green Energy had liabilities of 14.8 billion Canadian yen due within 12 months and liabilities of 32.3 billion Canadian yen due beyond 12 months. On the other hand, it had liquid assets of 5.92 billion Canadian yen and 8.17 billion national yen of receivables due within the year. It therefore has liabilities totaling 33.0 billion Canadian yen more than its cash and short-term receivables, combined.
This deficit is considerable compared to its market capitalization of 34.5 billion Canadian yen, so it suggests that shareholders monitor China Suntien Green Energy’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
With a net debt to EBITDA ratio of 5.0, it is fair to say that China Suntien Green Energy has significant debt. But the good news is that it has a pretty heartwarming 4.2x interest coverage, suggesting it can meet its obligations responsibly. On a slightly more positive note, China Suntien Green Energy increased its EBIT by 13% compared to last year, further increasing its ability to manage its debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether China Suntien Green Energy can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, China Suntien Green Energy has recorded substantial negative free cash flow, in total. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.
Our point of view
At first glance, China Suntien Green Energy’s net debt to EBITDA left us hesitant about the stock, and its EBIT-to-free-cash-flow conversion was no more attractive than the restaurant alone. empty on the busiest night of the year. But at least it’s decent enough to increase its EBIT; it’s encouraging. We are quite clear that we consider China Suntien Green Energy to be quite risky indeed, given the health of its balance sheet. For this reason, we are quite cautious about the stock and believe shareholders should keep a close eye on its liquidity. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example, we have identified 3 warning signs for China Suntien Green Energy (1 is a bit obnoxious) you should be aware.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.