Does Baoding Tianwei Baobian ElectricLtd (SHSE:600550) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Baoding Tianwei Baobian Electric Co.,Ltd. (SHSE:600550) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 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 Baoding Tianwei Baobian ElectricLtd

How Much Debt Does Baoding Tianwei Baobian ElectricLtd Carry?

As you can see below, at the end of September 2024, Baoding Tianwei Baobian ElectricLtd had CN¥2.53b of debt, up from CN¥1.52b a year ago. Click the image for more detail. However, it also had CN¥620.9m in cash, and so its net debt is CN¥1.91b.

A Look At Baoding Tianwei Baobian ElectricLtd's Liabilities

According to the last reported balance sheet, Baoding Tianwei Baobian ElectricLtd had liabilities of CN¥5.17b due within 12 months, and liabilities of CN¥1.01b due beyond 12 months. Offsetting these obligations, it had cash of CN¥620.9m as well as receivables valued at CN¥2.17b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.40b.

Baoding Tianwei Baobian ElectricLtd has a market capitalization of CN¥14.1b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Weak interest cover of 1.2 times and a disturbingly high net debt to EBITDA ratio of 9.3 hit our confidence in Baoding Tianwei Baobian ElectricLtd like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. The silver lining is that Baoding Tianwei Baobian ElectricLtd grew its EBIT by 314% last year, which nourishing like the idealism of youth. If it can keep walking that path it will be in a position to shed its debt with relative ease. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Baoding Tianwei Baobian ElectricLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Baoding Tianwei Baobian ElectricLtd recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Baoding Tianwei Baobian ElectricLtd's interest cover was a real negative on this analysis, as was its net debt to EBITDA. But like a ballerina ending on a perfect pirouette, it has not trouble growing its EBIT. When we consider all the elements mentioned above, it seems to us that Baoding Tianwei Baobian ElectricLtd is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Baoding Tianwei Baobian ElectricLtd has 1 warning sign we think you should be aware of.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 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.