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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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that China Energy Development Holdings Limited (HKG:228) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for China Energy Development Holdings
What Is China Energy Development Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that at December 2018 China Energy Development Holdings had debt of HK$188.3m, up from HK$122.3m in one year. However, because it has a cash reserve of HK$129.6m, its net debt is less, at about HK$58.8m.
How Strong Is China Energy Development Holdings's Balance Sheet?
The latest balance sheet data shows that China Energy Development Holdings had liabilities of HK$550.1m due within a year, and liabilities of HK$226.9m falling due after that. Offsetting this, it had HK$129.6m in cash and HK$444.3m in receivables that were due within 12 months. So its liabilities total HK$203.0m more than the combination of its cash and short-term receivables.
Since publicly traded China Energy Development Holdings shares are worth a total of HK$2.07b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.