These 4 Measures Indicate That ENN Natural GasLtd (SHSE:600803) Is Using Debt

Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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. We note that ENN Natural Gas Co.,Ltd. (SHSE:600803) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.

See our latest analysis for ENN Natural GasLtd

What Is ENN Natural GasLtd’s Debt?

The image below, which you can click on for greater detail, shows that ENN Natural GasLtd had debt of CN¥33.4b at the end of December 2023, a reduction from CN¥36.1b over a year. However, because it has a cash reserve of CN¥20.2b, its net debt is less, at about CN¥13.3b.

How Healthy Is ENN Natural GasLtd’s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that ENN Natural GasLtd had liabilities of CN¥46.0b due within 12 months and liabilities of CN¥30.0b due beyond that. On the other hand, it had cash of CN¥20.2b and CN¥12.0b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥43.8b.

This deficit is considerable relative to its market capitalization of CN¥58.4b, so it does suggest shareholders should keep an eye on ENN Natural GasLtd’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

ENN Natural GasLtd has a low debt to EBITDA ratio of only 0.80. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So there’s no doubt this company can take on debt while staying cool as a cucumber. On the other hand, ENN Natural GasLtd’s EBIT dived 18%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine ENN Natural GasLtd’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, ENN Natural GasLtd recorded free cash flow of 40% of its EBIT, which is weaker than we’d expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

ENN Natural GasLtd’s EBIT growth rate and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. We should also note that Gas Utilities industry companies like ENN Natural GasLtd commonly do use debt without problems. When we consider all the factors discussed, it seems to us that ENN Natural GasLtd is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. Be aware that ENN Natural GasLtd is showing 1 warning sign in our investment analysis , you should know about…

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.