Here’s why China Datang Corporation Renewable Power (HKG:1798) is burdened with debt

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 may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, China Datang Corporation Renewable Power Co., Limited (HKG:1798) is in debt. But the real question is whether this debt makes the business risky.

Why is debt risky?

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) event is when a company has to issue stock at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we look at debt levels, we first consider cash and debt levels, together.

See our latest analysis for China Datang Corporation Renewable Power

What is the net debt of China Datang Corporation Renewable Power?

The graph below, which you can click on for more details, shows that China Datang Corporation Renewable Power had a debt of 50.1 billion Canadian yen in June 2022; about the same as the previous year. However, he also had 4.93 billion yen in cash, so his net debt is 45.2 billion yen.

How healthy is China Datang Corporation Renewable Power’s balance sheet?

We can see from the most recent balance sheet that China Datang Corporation Renewable Power had liabilities of 15.9 billion yen coming due within a year, and liabilities of 45.3 billion yen due beyond. . On the other hand, it had a cash position of 4.93 billion Canadian yen and 13.8 billion national yen of receivables due within the year. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 42.5 billion Canadian yen.

This deficit casts a shadow over the CN¥14.2b society, like a colossus towering above mere mortals. We would therefore be watching his balance sheet closely, no doubt. After all, China Datang Corporation Renewable Power would likely need a major recapitalization if it were to pay its creditors today.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

While we are not concerned about China Datang Corporation Renewable Power’s net debt to EBITDA ratio of 4.8, we believe its extremely low interest coverage of 2.3 times is a sign of high leverage. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company lately. More worryingly, China Datang Corporation Renewable Power has seen its EBIT fall by 2.3% over the last twelve months. If this earnings trend continues, the company will face an uphill battle to pay off its debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine China Datang Corporation Renewable Power’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, China Datang Corporation Renewable Power has generated free cash flow of 8.5% of its EBIT, an uninspiring performance. This low level of cash conversion compromises its ability to manage and repay its debt.

Our point of view

Reflecting on China Datang Corporation Renewable Power’s attempt to rein in its total liabilities, we are certainly not enthusiastic. That said, its ability to grow its EBIT is not such a concern. After reviewing the data points discussed, we believe that China Datang Corporation Renewable Power has too much debt. While some investors like this kind of risky play, it’s definitely not our cup of tea. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 1 warning sign for China Datang Corporation Renewable Power you should know.

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.

Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.

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.