Ningbo BaoSi Energy Equipment (SZSE:300441) Seems To Use Debt Quite Sensibly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Ningbo BaoSi Energy Equipment Co., Ltd. (SZSE:300441) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Ningbo BaoSi Energy Equipment

What Is Ningbo BaoSi Energy Equipment's Debt?

As you can see below, Ningbo BaoSi Energy Equipment had CN¥119.6m of debt at September 2024, down from CN¥482.7m a year prior. But it also has CN¥554.8m in cash to offset that, meaning it has CN¥435.2m net cash.

A Look At Ningbo BaoSi Energy Equipment's Liabilities

According to the last reported balance sheet, Ningbo BaoSi Energy Equipment had liabilities of CN¥680.1m due within 12 months, and liabilities of CN¥186.9m due beyond 12 months. On the other hand, it had cash of CN¥554.8m and CN¥714.2m worth of receivables due within a year. So it can boast CN¥402.0m more liquid assets than total liabilities.

This surplus suggests that Ningbo BaoSi Energy Equipment has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Ningbo BaoSi Energy Equipment has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Ningbo BaoSi Energy Equipment grew its EBIT by 60% over the last twelve months, and that growth will make it easier to handle its 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 Ningbo BaoSi Energy Equipment can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Ningbo BaoSi Energy Equipment has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Ningbo BaoSi Energy Equipment saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Ningbo BaoSi Energy Equipment has net cash of CN¥435.2m, as well as more liquid assets than liabilities. And we liked the look of last year's 60% year-on-year EBIT growth. So we don't have any problem with Ningbo BaoSi Energy Equipment's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Ningbo BaoSi Energy Equipment has 3 warning signs (and 2 which shouldn't be ignored) we think you should know about.

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.

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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.