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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that REPT BATTERO Energy Co., Ltd. (HKG:666) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is REPT BATTERO Energy's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 REPT BATTERO Energy had CN¥9.63b of debt, an increase on CN¥4.65b, over one year. However, it does have CN¥8.96b in cash offsetting this, leading to net debt of about CN¥666.0m.

A Look At REPT BATTERO Energy's Liabilities

We can see from the most recent balance sheet that REPT BATTERO Energy had liabilities of CN¥15.0b falling due within a year, and liabilities of CN¥9.43b due beyond that. Offsetting these obligations, it had cash of CN¥8.96b as well as receivables valued at CN¥6.01b due within 12 months. So it has liabilities totalling CN¥9.51b more than its cash and near-term receivables, combined.

This deficit isn't so bad because REPT BATTERO Energy is worth CN¥30.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. 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 REPT BATTERO Energy'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.

In the last year REPT BATTERO Energy had a loss before interest and tax, and actually shrunk its revenue by 6.1%, to CN¥14b. That's not what we would hope to see.

Caveat Emptor

Importantly, REPT BATTERO Energy had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥1.9b at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥4.1b in negative free cash flow over the last twelve months. So in short it's a really risky stock. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how REPT BATTERO Energy's profit, revenue, and operating cashflow have changed over the last few years.

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.

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