Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Zheneng Jinjiang Environment Holding Company Limited (SGX:BWM) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Zheneng Jinjiang Environment Holding

What Is Zheneng Jinjiang Environment Holding's Net Debt?

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. Net debt is about the same, since the it doesn't have much cash.

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

The latest balance sheet data shows that Zheneng Jinjiang Environment Holding had liabilities of CN¥7.23b due within a year, and liabilities of CN¥7.10b falling due after 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 outweigh the sum of its cash and (near-term) receivables by CN¥10.9b.

This deficit casts a shadow over the CN¥1.53b 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 7.3, it's fair to say Zheneng Jinjiang Environment Holding does have a significant amount of debt. However, its interest coverage of 2.5 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual 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. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 4 warning signs for Zheneng Jinjiang Environment Holding (3 are significant!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.