Here's Why E Lighting Group Holdings (HKG:8222) Can Afford Some 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. As with many other companies E Lighting Group Holdings Limited (HKG:8222) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for E Lighting Group Holdings

How Much Debt Does E Lighting Group Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 E Lighting Group Holdings had HK$21.6m of debt, an increase on HK$20.3m, over one year. However, because it has a cash reserve of HK$12.0m, its net debt is less, at about HK$9.64m.

How Strong Is E Lighting Group Holdings' Balance Sheet?

The latest balance sheet data shows that E Lighting Group Holdings had liabilities of HK$21.9m due within a year, and liabilities of HK$7.53m falling due after that. Offsetting these obligations, it had cash of HK$12.0m as well as receivables valued at HK$219.0k due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$17.2m.

This deficit is considerable relative to its market capitalization of HK$21.2m, so it does suggest shareholders should keep an eye on E Lighting Group Holdings' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since E Lighting Group Holdings 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.

In the last year E Lighting Group Holdings had a loss before interest and tax, and actually shrunk its revenue by 9.7%, to HK$77m. We would much prefer see growth.

Caveat Emptor

Importantly, E Lighting Group Holdings had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable HK$4.6m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of HK$9.3m. In the meantime, we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that E Lighting Group Holdings is showing 1 warning sign in our investment analysis , you should know about...

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.