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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.' 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. Importantly, China Smarter Energy Group Holdings Limited (HKG:1004) does carry debt. But is this debt a concern to shareholders?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for China Smarter Energy Group Holdings
How Much Debt Does China Smarter Energy Group Holdings Carry?
As you can see below, China Smarter Energy Group Holdings had HK$2.25b of debt at December 2018, down from HK$2.73b a year prior. However, because it has a cash reserve of HK$179.0m, its net debt is less, at about HK$2.07b.
A Look At China Smarter Energy Group Holdings's Liabilities
According to the last reported balance sheet, China Smarter Energy Group Holdings had liabilities of HK$1.03b due within 12 months, and liabilities of HK$1.71b due beyond 12 months. Offsetting this, it had HK$179.0m in cash and HK$578.4m in receivables that were due within 12 months. So its liabilities total HK$1.98b more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of HK$2.53b. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).