These 4 Measures Indicate That Tonking New Energy Group Holdings (HKG:8326) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Tonking New Energy Group Holdings Limited (HKG:8326) does use debt in its business. 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. If things get really bad, the lenders can take control of the business. 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. 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.

Check out our latest analysis for Tonking New Energy Group Holdings

What Is Tonking New Energy Group Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Tonking New Energy Group Holdings had HK$96.2m of debt, an increase on HK$85.4m, over one year. On the flip side, it has HK$54.6m in cash leading to net debt of about HK$41.6m.

How Healthy Is Tonking New Energy Group Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tonking New Energy Group Holdings had liabilities of HK$258.1m due within 12 months and liabilities of HK$2.12m due beyond that. On the other hand, it had cash of HK$54.6m and HK$361.2m worth of receivables due within a year. So it can boast HK$155.7m more liquid assets than total liabilities.

This surplus strongly suggests that Tonking New Energy Group Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Tonking New Energy Group Holdings has a low net debt to EBITDA ratio of only 0.96. And its EBIT covers its interest expense a whopping 12.6 times over. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Tonking New Energy Group Holdings grew its EBIT by 630% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tonking New Energy 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent two years, Tonking New Energy Group Holdings recorded free cash flow worth 75% 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.

Our View

Tonking New Energy Group Holdings's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Based on the data we have reviewed, it's as clear as day that Tonking New Energy Group Holdings's balance sheet is as healthy as a vaccinated Olympian. We're no more concerned about its debt than sailing off the edge of the earth. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Tonking New Energy Group Holdings has 3 warning signs (and 2 which shouldn't be ignored) we think you should know about.

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.