We Think Triumph New Energy (HKG:1108) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Triumph New Energy Company Limited (HKG:1108) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Triumph New Energy

How Much Debt Does Triumph New Energy Carry?

The image below, which you can click on for greater detail, shows that at September 2023 Triumph New Energy had debt of CN¥3.81b, up from CN¥2.73b in one year. However, because it has a cash reserve of CN¥878.3m, its net debt is less, at about CN¥2.93b.

How Healthy Is Triumph New Energy's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Triumph New Energy had liabilities of CN¥4.41b due within 12 months and liabilities of CN¥2.42b due beyond that. Offsetting this, it had CN¥878.3m in cash and CN¥2.79b in receivables that were due within 12 months. So its liabilities total CN¥3.17b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Triumph New Energy has a market capitalization of CN¥6.05b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Triumph New Energy has net debt to EBITDA of 4.9 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 7.4 suggests it can easily service that debt. Pleasingly, Triumph New Energy is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 123% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Triumph New Energy'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Triumph New Energy 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.

Our View

Neither Triumph New Energy's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But the good news is it seems to be able to grow its EBIT with ease. When we consider all the factors discussed, it seems to us that Triumph New Energy 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. For example - Triumph New Energy has 2 warning signs we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.