David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Aotecar New Energy Technology Co., Ltd. (SZSE:002239) does carry debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Aotecar New Energy Technology's Debt?
The image below, which you can click on for greater detail, shows that at March 2024 Aotecar New Energy Technology had debt of CN¥2.02b, up from CN¥1.68b in one year. However, its balance sheet shows it holds CN¥2.12b in cash, so it actually has CN¥105.3m net cash.
A Look At Aotecar New Energy Technology's Liabilities
We can see from the most recent balance sheet that Aotecar New Energy Technology had liabilities of CN¥6.40b falling due within a year, and liabilities of CN¥500.6m due beyond that. Offsetting these obligations, it had cash of CN¥2.12b as well as receivables valued at CN¥3.03b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.74b.
This deficit isn't so bad because Aotecar New Energy Technology is worth CN¥7.49b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Aotecar New Energy Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.
It is just as well that Aotecar New Energy Technology's load is not too heavy, because its EBIT was down 76% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Aotecar New Energy Technology 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 company can only pay off debt with cold hard cash, not accounting profits. Aotecar New Energy Technology 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. Over the last two years, Aotecar New Energy Technology saw substantial negative free cash flow, in total. 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.
Summing Up
While Aotecar New Energy Technology does have more liabilities than liquid assets, it also has net cash of CN¥105.3m. So although we see some areas for improvement, we're not too worried about Aotecar New Energy Technology's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Aotecar New Energy Technology is showing 2 warning signs in our investment analysis , 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.
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