Add New Energy Investment Holdings Group (HKG:2623) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Add New Energy Investment Holdings Group Limited (HKG:2623) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Add New Energy Investment Holdings Group

What Is Add New Energy Investment Holdings Group's Net Debt?

The image below, which you can click on for greater detail, shows that Add New Energy Investment Holdings Group had debt of CN¥123.4m at the end of December 2022, a reduction from CN¥180.6m over a year. However, its balance sheet shows it holds CN¥124.7m in cash, so it actually has CN¥1.26m net cash.

How Strong Is Add New Energy Investment Holdings Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Add New Energy Investment Holdings Group had liabilities of CN¥378.0m due within 12 months and liabilities of CN¥14.1m due beyond that. On the other hand, it had cash of CN¥124.7m and CN¥40.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥227.0m.

When you consider that this deficiency exceeds the company's CN¥217.6m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Given that Add New Energy Investment Holdings Group 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.

Although Add New Energy Investment Holdings Group made a loss at the EBIT level, last year, it was also good to see that it generated CN¥78m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Add New Energy Investment Holdings Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Add New Energy Investment Holdings Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent year, Add New Energy Investment Holdings Group recorded free cash flow worth 77% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Add New Energy Investment Holdings Group does have more liabilities than liquid assets, it also has net cash of CN¥1.26m. The cherry on top was that in converted 77% of that EBIT to free cash flow, bringing in CN¥61m. So we are not troubled with Add New Energy Investment Holdings Group's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Add New Energy Investment Holdings Group has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.