David Iben put it well when he said, “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ 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, China Lesso Group Holdings Limited (HKG: 2128) carries a debt. But should shareholders be concerned about its use of debt?
When is Debt a Problem?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Check out our latest analysis for China Lesso Group Holdings
What is the debt of China Lesso Group Holdings?
The image below, which you can click for more details, shows that in June 2021, China Lesso Group Holdings had CN 18.9 billion in debt, compared to CN’s 15.3 billion in one year. However, it has CN7.57 billion in cash offsetting this, which leads to net debt of around CNN 11.3 billion.
A look at the liabilities of China Lesso Group Holdings
We can see from the most recent balance sheet that China Lesso Group Holdings had CN 20.4 billion liabilities due within one year and CN 10.7 billion liabilities due beyond. . In return, he had CN 7.57 billion in cash and CN 6.96 billion in receivables due within 12 months. It therefore has liabilities totaling 16.5 billion yen more than its cash and short-term receivables combined.
This is a mountain of leverage compared to its market cap of CN ¥ 27.4b. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution.
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). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
We would say that China Lesso Group Holdings’ moderate net debt to EBITDA ratio (or 1.8) indicates debt cautiousness. And its strong coverage interest of 20.1 times, makes us even more comfortable. We note that China Lesso Group Holdings has increased its EBIT by 24% over the past year, which should make it easier to repay debt in the future. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether China Lesso Group Holdings can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, China Lesso Group Holdings’ free cash flow has been 40% of its EBIT, less than we expected. It’s not great when it comes to paying down debt.
Our point of view
China Lesso Group Holdings’ interest coverage was a real asset in this analysis, as was its EBIT growth rate. On the other hand, its level of total liabilities makes us a little less comfortable with its debt. When we consider all the elements mentioned above, it seems to us that China Lesso Group Holdings is managing its debt quite well. But beware: we believe debt levels are high enough to warrant continued monitoring. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. We have identified 1 warning sign with China Lesso Group Holdings, and understanding them should be part of your investment process.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash-flow net-growth stocks.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.