Is Datang International Power Generation (HKG:991) a risky investment?
Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that Datang International Power Generation Co.,Ltd. (HKG:991) uses debt in his business. But the real question is whether this debt makes the business risky.
When is debt a problem?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for Datang International Power Generation
What is Datang International Power Generation’s debt?
As you can see below, Datang International Power Generation had a debt of 155.0 billion Canadian yen in September 2021, roughly the same as the previous year. You can click on the graph for more details. However, since it has a cash reserve of 10.6 billion Canadian yen, its net debt is less, at around 144.4 billion Canadian yen.
A look at the liabilities of Datang International Power Generation
The latest balance sheet data shows that Datang International Power Generation had liabilities of 77.8 billion yen maturing within one year, and liabilities of 114.8 billion yen maturing thereafter. As compensation for these obligations, it had cash of 10.6 billion Canadian yen as well as receivables worth 19.2 billion national yen due within 12 months. Thus, its liabilities total 162.7 billion Canadian yen more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the company itself, like a child struggling under the weight of a huge backpack full of books, his sports gear and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Datang International Power Generation would likely need a major recapitalization if it were to pay its creditors today.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
A low interest coverage of 2.2 times and an extremely high net debt to EBITDA ratio of 7.0 shook our confidence in Datang International Power Generation like a punch in the gut. The debt burden here is considerable. Worse still, Datang International Power Generation’s EBIT was down 57% from last year. If the profits continue like this in the long term, there is an unimaginable chance of repaying this debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Datang International Power Generation’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a company can only repay its debts with cash, not book profits. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Datang International Power Generation has generated free cash flow of a very strong 83% of its EBIT, more than expected. This positions him well to pay off debt if desired.
Our point of view
At first glance, Datang International Power Generation’s EBIT growth rate left us hesitant about the stock, and its level of total liabilities was no more appealing than the single empty restaurant on the busiest night of the year. year. But at least it’s decent enough to convert EBIT to free cash flow; it’s encouraging. We are quite clear that we consider Datang International Power Generation to be really quite risky, given the health of its balance sheet. For this reason, we are quite cautious about the stock and believe shareholders should keep a close eye on its liquidity. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example Datang International Power Generation has 5 warning signs (and 1 which is significant) that we think you should know about.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-flowing growth stocks without further ado.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.