Here's Why Add New Energy Investment Holdings Group (HKG:2623) Has A Meaningful Debt Burden

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 real question is whether this debt is making the company risky.

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. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Add New Energy Investment Holdings Group

How Much Debt Does Add New Energy Investment Holdings Group Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Add New Energy Investment Holdings Group had debt of CN¥189.5m, up from CN¥162.5m in one year. However, it also had CN¥124.4m in cash, and so its net debt is CN¥65.1m.

How Healthy 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¥188.3m falling due within a year, and liabilities of CN¥146.6m due beyond that. Offsetting this, it had CN¥124.4m in cash and CN¥36.7m in receivables that were due within 12 months. So it has liabilities totalling CN¥173.8m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Add New Energy Investment Holdings Group is worth CN¥516.9m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Add New Energy Investment Holdings Group has net debt of just 0.64 times EBITDA, suggesting it could ramp leverage without breaking a sweat. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. 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¥86m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Add New Energy Investment Holdings Group'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Add New Energy Investment Holdings Group recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Add New Energy Investment Holdings Group's conversion of EBIT to free cash flow 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. Looking at all the angles mentioned above, it does seem to us that Add New Energy Investment Holdings Group is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Add New Energy Investment Holdings Group (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

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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