Is Denox Environmental & Technology Holdings (HKG:1452) Using Debt Sensibly?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Denox Environmental & Technology Holdings Limited (HKG:1452) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

Check out our latest analysis for Denox Environmental & Technology Holdings

What Is Denox Environmental & Technology Holdings's Net Debt?

As you can see below, at the end of June 2024, Denox Environmental & Technology Holdings had CN¥13.0m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥65.7m in cash, so it actually has CN¥52.7m net cash.

How Strong Is Denox Environmental & Technology Holdings' Balance Sheet?

We can see from the most recent balance sheet that Denox Environmental & Technology Holdings had liabilities of CN¥260.6m falling due within a year, and liabilities of CN¥3.65m due beyond that. Offsetting these obligations, it had cash of CN¥65.7m as well as receivables valued at CN¥18.2m due within 12 months. So it has liabilities totalling CN¥180.3m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥44.1m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Denox Environmental & Technology Holdings would likely require a major re-capitalisation if it had to pay its creditors today. Given that Denox Environmental & Technology Holdings has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. When analysing debt levels, the balance sheet is the obvious place to start. But it is Denox Environmental & Technology Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Denox Environmental & Technology Holdings reported revenue of CN¥126m, which is a gain of 57%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Denox Environmental & Technology Holdings?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Denox Environmental & Technology Holdings lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CN¥19m and booked a CN¥25m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of CN¥52.7m. That means it could keep spending at its current rate for more than two years. Denox Environmental & Technology Holdings's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Denox Environmental & Technology Holdings is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.