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. As with many other companies Baozun Inc. (NASDAQ:BZUN) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Baozun Carry?
As you can see below, Baozun had CN¥2.08b of debt, at June 2020, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥2.33b in cash to offset that, meaning it has CN¥252.1m net cash.
How Strong Is Baozun's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Baozun had liabilities of CN¥1.97b due within 12 months and liabilities of CN¥2.16b due beyond that. Offsetting this, it had CN¥2.33b in cash and CN¥1.58b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥217.5m.
This state of affairs indicates that Baozun's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥17.0b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Baozun boasts net cash, so it's fair to say it does not have a heavy debt load!
Also good is that Baozun grew its EBIT at 17% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Baozun 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 company can only pay off debt with cold hard cash, not accounting profits. Baozun 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. During the last three years, Baozun burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
We could understand if investors are concerned about Baozun's liabilities, but we can be reassured by the fact it has has net cash of CN¥252.1m. And we liked the look of last year's 17% year-on-year EBIT growth. So we don't have any problem with Baozun's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Baozun you should be aware of, and 1 of them is potentially serious.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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