Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that BGMC International Limited (HKG:1693) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does BGMC International Carry?
As you can see below, BGMC International had RM272.8m of debt at March 2019, down from RM286.1m a year prior. However, it does have RM66.3m in cash offsetting this, leading to net debt of about RM206.6m.
How Strong Is BGMC International's Balance Sheet?
We can see from the most recent balance sheet that BGMC International had liabilities of RM320.0m falling due within a year, and liabilities of RM207.7m due beyond that. Offsetting this, it had RM66.3m in cash and RM365.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM95.8m.
This is a mountain of leverage relative to its market capitalization of RM158.1m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since BGMC International 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.
In the last year BGMC International actually shrunk its revenue by 49%, to RM333m. To be frank that doesn't bode well.
Not only did BGMC International's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable RM89m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through RM66m of cash over the last year. So suffice it to say we consider the stock very risky. For riskier companies like BGMC International I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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