Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Weigang Environmental Technology Holding Group Limited (HKG:1845) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Weigang Environmental Technology Holding Group's Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2019 Weigang Environmental Technology Holding Group had CN¥26.6m of debt, an increase on CN¥10.0m, over one year. But it also has CN¥199.3m in cash to offset that, meaning it has CN¥172.7m net cash.
How Strong Is Weigang Environmental Technology Holding Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Weigang Environmental Technology Holding Group had liabilities of CN¥223.9m due within 12 months and liabilities of CN¥3.96m due beyond that. Offsetting these obligations, it had cash of CN¥199.3m as well as receivables valued at CN¥418.3m due within 12 months. So it can boast CN¥389.7m more liquid assets than total liabilities.
This surplus liquidity suggests that Weigang Environmental Technology Holding Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Succinctly put, Weigang Environmental Technology Holding Group boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Weigang Environmental Technology Holding Group grew its EBIT by 31% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Weigang Environmental Technology Holding Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Weigang Environmental Technology Holding Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Weigang Environmental Technology Holding Group burned a lot of cash. 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.
While it is always sensible to investigate a company's debt, in this case Weigang Environmental Technology Holding Group has CN¥172.7m in net cash and a decent-looking balance sheet. And we liked the look of last year's 31% year-on-year EBIT growth. So we don't think Weigang Environmental Technology Holding Group's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Consider risks, for instance. Every company has them, and we've spotted 3 warning signs for Weigang Environmental Technology Holding Group you should know about.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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.
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