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These 4 Measures Indicate That Dynagreen Environmental Protection Group (HKG:1330) Is Using Debt Extensively

Simply Wall St

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.' 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. As with many other companies Dynagreen Environmental Protection Group Co., Ltd. (HKG:1330) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Dynagreen Environmental Protection Group

How Much Debt Does Dynagreen Environmental Protection Group Carry?

The image below, which you can click on for greater detail, shows that at March 2019 Dynagreen Environmental Protection Group had debt of CN¥5.96b, up from CN¥3.58b in one year. However, it also had CN¥566.8m in cash, and so its net debt is CN¥5.39b.

SEHK:1330 Historical Debt, August 27th 2019

How Healthy Is Dynagreen Environmental Protection Group's Balance Sheet?

The latest balance sheet data shows that Dynagreen Environmental Protection Group had liabilities of CN¥3.39b due within a year, and liabilities of CN¥4.93b falling due after that. Offsetting this, it had CN¥566.8m in cash and CN¥672.0m in receivables that were due within 12 months. So it has liabilities totalling CN¥7.09b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥10.7b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Dynagreen Environmental Protection Group shareholders face the double whammy of a high net debt to EBITDA ratio (8.4), and fairly weak interest coverage, since EBIT is just 2.5 times the interest expense. The debt burden here is substantial. Looking on the bright side, Dynagreen Environmental Protection Group boosted its EBIT by a silky 31% 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Dynagreen Environmental Protection Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Dynagreen Environmental Protection Group saw substantial negative free cash flow, in total. 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

To be frank both Dynagreen Environmental Protection Group's net debt to EBITDA and its track record of converting EBIT to free cash flow 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. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Dynagreen Environmental Protection Group stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. Given Dynagreen Environmental Protection Group has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.