Some say volatility, rather than debt, is the best way to view risk as an investor, but Warren Buffett said “volatility is far from risk.” So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. Above all, GCL New Energy Holdings Limited (HKG: 451) carries a debt. But the real question is whether this debt makes the business risky.
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest analysis for GCL New Energy Holdings
What is the debt of GCL New Energy Holdings?
As you can see below, GCL New Energy Holdings had a debt of CN 12.9 billion in June 2021, up from CN 33.8 billion the previous year. However, he has CN 618.0 million in cash offsetting this, leading to net debt of around CN 12.3 billion.
A look at the liabilities of GCL New Energy Holdings
Zooming in on the latest balance sheet data, we can see that GCL New Energy Holdings had CN 14.7 billion in liabilities due within 12 months and CN in 8.12 billion liabilities beyond. On the other hand, he had a cash position of CN 618.0 million and CN 6.85 billion in receivables due within one year. Its liabilities therefore total CN 15.3 billion more than the combination of its cash and short-term receivables.
Deficiency here weighs heavily on the CN ¥ 6.30b company itself, as if a child struggles under the weight of a huge backpack full of books, his sports equipment and a trumpet. We therefore believe that shareholders should monitor it closely. Ultimately, GCL New Energy Holdings would likely need a major recapitalization if its creditors demanded repayment.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While we are not worried about GCL New Energy Holdings’ net debt to EBITDA ratio of 3.8, we do think its ultra-low 0.89 times interest coverage is a sign of high leverage. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. Worse yet, GCL New Energy Holdings has seen its EBIT reach 41% over the past 12 months. If the income continues like this for the long haul, there is an incredible chance to pay off that debt. There is no doubt that we learn the most about debt from the balance sheet. But it is future earnings, more than anything, that will determine GCL New Energy Holdings’ ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, GCL New Energy Holdings has practically reached breakeven point on a free cash flow basis. While many businesses operate at breakeven, we prefer to see substantial free cash flow, especially if they are already dead.
Our point of view
To be frank, GCL New Energy Holdings’ EBIT growth rate and its history of staying above its total liabilities make us rather uncomfortable with its debt levels. And even his conversion from EBIT to free cash flow doesn’t inspire much confidence. Considering all of the above factors, we believe GCL New Energy Holdings is seriously in debt. For us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may think differently. The balance sheet is clearly the area you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we discovered 3 warning signs for GCL New Energy Holdings (1 doesn’t suit us very well!) Which you should be aware of before investing here.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, don’t hesitate to check out our exclusive list of cash-flow-growing stocks today.
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