These 4 Measures Indicate That Hotai MotorLtd (TWSE:2207) Is Using Debt Extensively

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Hotai Motor Co.,Ltd. (TWSE:2207) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Hotai MotorLtd

What Is Hotai MotorLtd's Debt?

As you can see below, at the end of September 2024, Hotai MotorLtd had NT$319.8b of debt, up from NT$294.7b a year ago. Click the image for more detail. However, it does have NT$34.1b in cash offsetting this, leading to net debt of about NT$285.7b.

How Healthy Is Hotai MotorLtd's Balance Sheet?

The latest balance sheet data shows that Hotai MotorLtd had liabilities of NT$358.5b due within a year, and liabilities of NT$41.2b falling due after that. Offsetting these obligations, it had cash of NT$34.1b as well as receivables valued at NT$305.0b due within 12 months. So it has liabilities totalling NT$60.7b more than its cash and near-term receivables, combined.

Since publicly traded Hotai MotorLtd shares are worth a very impressive total of NT$343.7b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

With a net debt to EBITDA ratio of 6.1, it's fair to say Hotai MotorLtd does have a significant amount of debt. However, its interest coverage of 4.9 is reasonably strong, which is a good sign. It is well worth noting that Hotai MotorLtd's EBIT shot up like bamboo after rain, gaining 70% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hotai MotorLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Hotai MotorLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Hotai MotorLtd's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. We think that Hotai MotorLtd's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. Case in point: We've spotted 3 warning signs for Hotai MotorLtd you should be aware of, and 2 of them don't sit too well with us.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.