Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies China Resources Gas Group Limited (HKG:1193) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is China Resources Gas Group's Net Debt?
The image below, which you can click on for greater detail, shows that at December 2018 China Resources Gas Group had debt of HK$12.6b, up from HK$11.8b in one year. However, it does have HK$12.0b in cash offsetting this, leading to net debt of about HK$529.5m.
How Healthy Is China Resources Gas Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that China Resources Gas Group had liabilities of HK$34.2b due within 12 months and liabilities of HK$7.72b due beyond that. On the other hand, it had cash of HK$12.0b and HK$7.97b worth of receivables due within a year. So it has liabilities totalling HK$22.0b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since China Resources Gas Group has a huge market capitalization of HK$87.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. But either way, China Resources Gas Group has virtually no net debt, so it's fair to say it does not have a heavy debt load!
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.
China Resources Gas Group has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.063 and EBIT of 53.0 times the interest expense. So relative to past earnings, the debt load seems trivial. And we also note warmly that China Resources Gas Group grew its EBIT by 19% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine China Resources Gas Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, China Resources Gas Group produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Happily, China Resources Gas Group's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. We would also note that Gas Utilities industry companies like China Resources Gas Group commonly do use debt without problems. Looking at the bigger picture, we think China Resources Gas Group's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you're interested in China Resources Gas Group, you may well want to click here to check an interactive graph of its earnings per share history.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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 email@example.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.