Beijing SOJO Electric (SZSE:300444) Takes On Some Risk With Its Use Of Debt

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.' 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. We can see that Beijing SOJO Electric Co., Ltd. (SZSE:300444) does use debt in its business. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Beijing SOJO Electric

How Much Debt Does Beijing SOJO Electric Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Beijing SOJO Electric had CN¥1.38b of debt, an increase on CN¥703.9m, over one year. On the flip side, it has CN¥289.6m in cash leading to net debt of about CN¥1.09b.

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How Strong Is Beijing SOJO Electric's Balance Sheet?

According to the last reported balance sheet, Beijing SOJO Electric had liabilities of CN¥3.05b due within 12 months, and liabilities of CN¥1.08b due beyond 12 months. On the other hand, it had cash of CN¥289.6m and CN¥2.23b worth of receivables due within a year. So it has liabilities totalling CN¥1.61b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Beijing SOJO Electric is worth CN¥6.32b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Beijing SOJO Electric's debt is 4.0 times its EBITDA, and its EBIT cover its interest expense 6.5 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably, Beijing SOJO Electric's EBIT launched higher than Elon Musk, gaining a whopping 618% on last year. There's no doubt that we learn most about debt from the balance sheet. But it is Beijing SOJO Electric's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last two years, Beijing SOJO Electric 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.

Our View

Beijing SOJO Electric's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Beijing SOJO Electric is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Beijing SOJO Electric 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.