Add New Energy Investment Holdings Group (HKG:2623) Takes On Some Risk With Its Use Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. 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?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Add New Energy Investment Holdings Group

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

You can click the graphic below for the historical numbers, but it shows that Add New Energy Investment Holdings Group had CN¥30.0m of debt in December 2023, down from CN¥123.4m, one year before. However, it does have CN¥146.1m in cash offsetting this, leading to net cash of CN¥116.1m.

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

We can see from the most recent balance sheet that Add New Energy Investment Holdings Group had liabilities of CN¥261.3m falling due within a year, and liabilities of CN¥116.1m due beyond that. Offsetting this, it had CN¥146.1m in cash and CN¥31.8m in receivables that were due within 12 months. So its liabilities total CN¥199.5m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥108.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Add New Energy Investment Holdings Group would probably need a major re-capitalization if its creditors were to demand repayment. 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.

But the bad news is that Add New Energy Investment Holdings Group has seen its EBIT plunge 19% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is Add New Energy Investment Holdings Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. Looking at the most recent two years, Add New Energy Investment Holdings Group recorded free cash flow of 43% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

Although Add New Energy Investment Holdings Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥116.1m. Despite the cash, we do find Add New Energy Investment Holdings Group's level of total liabilities concerning, so we're not particularly comfortable with the stock. 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. We've identified 2 warning signs with Add New Energy Investment Holdings Group , and understanding them should be part of your investment process.

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.