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GCL-Poly Energy Holdings (HKG:3800) Has A Mountain Of Debt

Simply Wall St

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. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies GCL-Poly Energy Holdings Limited (HKG:3800) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for GCL-Poly Energy Holdings

What Is GCL-Poly Energy Holdings's Net Debt?

As you can see below, GCL-Poly Energy Holdings had CN¥61.4b of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. On the flip side, it has CN¥3.83b in cash leading to net debt of about CN¥57.6b.

SEHK:3800 Historical Debt, October 2nd 2019
SEHK:3800 Historical Debt, October 2nd 2019

How Strong Is GCL-Poly Energy Holdings's Balance Sheet?

The latest balance sheet data shows that GCL-Poly Energy Holdings had liabilities of CN¥51.5b due within a year, and liabilities of CN¥35.0b falling due after that. Offsetting this, it had CN¥3.83b in cash and CN¥14.9b in receivables that were due within 12 months. So it has liabilities totalling CN¥67.8b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥5.70b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt After all, GCL-Poly Energy Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Weak interest cover of 0.29 times and a disturbingly high net debt to EBITDA ratio of 10.2 hit our confidence in GCL-Poly Energy Holdings like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, GCL-Poly Energy Holdings's EBIT was down 77% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine GCL-Poly Energy Holdings'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, GCL-Poly Energy Holdings 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

On the face of it, GCL-Poly Energy Holdings's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its interest cover fails to inspire much confidence. It looks to us like GCL-Poly Energy Holdings carries a significant balance sheet burden. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. While GCL-Poly Energy Holdings didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away.Click here to see if its earnings are heading in the right direction, over the medium term.

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.

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.