Is LongiTech Smart Energy Holding (HKG:1281) A Risky Investment?

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.' 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 LongiTech Smart Energy Holding Limited (HKG:1281) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for LongiTech Smart Energy Holding

How Much Debt Does LongiTech Smart Energy Holding Carry?

You can click the graphic below for the historical numbers, but it shows that LongiTech Smart Energy Holding had CN¥235.4m of debt in December 2020, down from CN¥534.4m, one year before. However, it does have CN¥227.8m in cash offsetting this, leading to net debt of about CN¥7.64m.

A Look At LongiTech Smart Energy Holding's Liabilities

Zooming in on the latest balance sheet data, we can see that LongiTech Smart Energy Holding had liabilities of CN¥118.6m due within 12 months and liabilities of CN¥233.9m due beyond that. On the other hand, it had cash of CN¥227.8m and CN¥441.5m worth of receivables due within a year. So it can boast CN¥316.8m more liquid assets than total liabilities.

This surplus strongly suggests that LongiTech Smart Energy Holding has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

LongiTech Smart Energy Holding has a very low debt to EBITDA ratio of 0.16 so it is strange to see weak interest coverage, with last year's EBIT being only 1.2 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. We also note that LongiTech Smart Energy Holding improved its EBIT from a last year's loss to a positive CN¥19m. There's no doubt that we learn most about debt from the balance sheet. But it is LongiTech Smart Energy Holding'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Considering the last year, LongiTech Smart Energy Holding actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

The good news is that LongiTech Smart Energy Holding's demonstrated ability to handle its total liabilities delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its interest cover. All these things considered, it appears that LongiTech Smart Energy Holding can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. We've identified 4 warning signs with LongiTech Smart Energy Holding (at least 1 which is concerning) , and understanding them should be part of your investment process.

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. 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.
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