David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We can see that COSCO SHIPPING Energy Transportation Co., Ltd. (HKG:1138) uses debt in his business. But the more important question is: what risk does this debt create?

When is debt a problem?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, many companies use debt to finance their growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.

Check out our latest analysis for COSCO SHIPPING Energy Transportation

What is COSCO SHIPPING Energy Transportation’s debt?

As you can see below, COSCO SHIPPING Energy Transportation had a debt of 23.2 billion yen in September 2021, compared to 25.1 billion yen the previous year. However, he also had 3.28 billion yen in cash, so his net debt is 19.9 billion yen.

How strong is COSCO SHIPPING Energy Transportation’s balance sheet?

The latest balance sheet data shows that COSCO SHIPPING Energy Transportation had liabilities of 9.25 billion yen maturing within one year, and liabilities of 20.1 billion yen maturing thereafter. In return, he had 3.28 billion yen in cash and 1.93 billion yen in debt due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of 24.2 billion Canadian yen.

Given that this deficit is actually greater than the company’s market capitalization of 20.2 billion Canadian yen, we think shareholders should really be watching COSCO SHIPPING Energy Transportation’s debt levels, like a parent watching her child riding a bike for the first time. In the scenario where the company were to quickly clean up its balance sheet, it seems likely that shareholders would suffer significant dilution.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

In this case, COSCO SHIPPING Energy Transportation has a rather concerning net debt to EBITDA ratio of 6.1, but very high interest coverage of 1k. This means that unless the company has access to very cheap debt, these interest charges will likely increase in the future. It is important to note that the EBIT of COSCO SHIPPING Energy Transportation has fallen by 82% in the last twelve months. If this decline continues, it will be more difficult to repay debts than to sell foie gras at a vegan convention. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether COSCO SHIPPING Energy Transportation can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, while the taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, COSCO SHIPPING Energy Transportation has recorded free cash flow of 93% of its EBIT, which is higher than what we usually expect. This positions him well to pay off debt if desired.

Our point of view

At first glance, COSCO SHIPPING Energy Transportation’s net debt to EBITDA ratio left us hesitant about the stock, and its EBIT growth rate was no more appealing than the single empty restaurant on the darkest night. busy year. But on the bright side, its interest coverage is a good sign and makes us more optimistic. Looking at the balance sheet and taking all of these factors into account, we think debt makes COSCO SHIPPING Energy Transportation stock a bit risky. Some people like that kind of risk, but we’re aware of the potential pitfalls, so we’d probably prefer it to take on less debt. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. To do this, you need to find out about the 3 warning signs we spotted with COSCO SHIPPING Energy Transportation (including 1 which does not suit us too much).

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

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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.