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 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 note that Concord New Energy Group Limited (HKG:182) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Concord New Energy Group's Net Debt?

As you can see below, at the end of December 2023, Concord New Energy Group had CN¥16.5b of debt, up from CN¥13.9b a year ago. Click the image for more detail. However, it does have CN¥2.60b in cash offsetting this, leading to net debt of about CN¥13.9b.

A Look At Concord New Energy Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Concord New Energy Group had liabilities of CN¥6.88b due within 12 months and liabilities of CN¥15.9b due beyond that. On the other hand, it had cash of CN¥2.60b and CN¥2.56b worth of receivables due within a year. So its liabilities total CN¥17.6b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥4.61b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Concord New Energy Group would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.6 times and a disturbingly high net debt to EBITDA ratio of 8.4 hit our confidence in Concord New Energy Group like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Another concern for investors might be that Concord New Energy Group's EBIT fell 11% in the last year. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Concord New Energy Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept 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, Concord New Energy Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Concord New Energy Group's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its interest cover also fails to instill confidence. We think the chances that Concord New Energy Group has too much debt a very significant. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Concord New Energy Group has 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com