Is China Ecotek (TWSE:1535) A Risky Investment?

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 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. As with many other companies China Ecotek Corporation (TWSE:1535) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 China Ecotek

What Is China Ecotek's Debt?

As you can see below, at the end of December 2023, China Ecotek had NT$100.0m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds NT$1.18b in cash, so it actually has NT$1.08b net cash.

How Strong Is China Ecotek's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Ecotek had liabilities of NT$2.87b due within 12 months and liabilities of NT$309.2m due beyond that. On the other hand, it had cash of NT$1.18b and NT$2.06b worth of receivables due within a year. So it can boast NT$65.4m more liquid assets than total liabilities.

This state of affairs indicates that China Ecotek's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the NT$10.3b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, China Ecotek boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that China Ecotek has boosted its EBIT by 40%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China Ecotek will need earnings to service that debt. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. China Ecotek 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. During the last three years, China Ecotek burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Ecotek has NT$1.08b in net cash and a decent-looking balance sheet. And we liked the look of last year's 40% year-on-year EBIT growth. So we don't have any problem with China Ecotek's use of debt. 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 China Ecotek has 2 warning signs (and 1 which is concerning) 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.