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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Bosideng International Holdings Limited (HKG:3998) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is Bosideng International Holdings's Debt?
The image below, which you can click on for greater detail, shows that Bosideng International Holdings had debt of CN¥1.63b at the end of March 2019, a reduction from CN¥2.34b over a year. However, its balance sheet shows it holds CN¥6.78b in cash, so it actually has CN¥5.16b net cash.
A Look At Bosideng International Holdings's Liabilities
We can see from the most recent balance sheet that Bosideng International Holdings had liabilities of CN¥4.80b falling due within a year, and liabilities of CN¥178.0m due beyond that. On the other hand, it had cash of CN¥6.78b and CN¥1.36b worth of receivables due within a year. So it actually has CN¥3.17b more liquid assets than total liabilities.
This short term liquidity is a sign that Bosideng International Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Bosideng International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Another good sign is that Bosideng International Holdings has been able to increase its EBIT by 30% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Bosideng International Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Bosideng International Holdings 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 three years, Bosideng International Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While we empathize with investors who find debt concerning, you should keep in mind that Bosideng International Holdings has net cash of CN¥5.2b, as well as more liquid assets than liabilities. The cherry on top was that in converted 101% of that EBIT to free cash flow, bringing in CN¥1.2b. So we don't think Bosideng International Holdings's use of debt is risky. We'd be very excited to see if Bosideng International Holdings insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.