We Think Baoxiniao Holding (SZSE:002154) Can Manage Its Debt With Ease

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. Importantly, Baoxiniao Holding Co., Ltd. (SZSE:002154) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Baoxiniao Holding

How Much Debt Does Baoxiniao Holding Carry?

The image below, which you can click on for greater detail, shows that at September 2023 Baoxiniao Holding had debt of CN¥714.2m, up from CN¥382.2m in one year. But it also has CN¥1.83b in cash to offset that, meaning it has CN¥1.11b net cash.

How Healthy Is Baoxiniao Holding's Balance Sheet?

The latest balance sheet data shows that Baoxiniao Holding had liabilities of CN¥2.25b due within a year, and liabilities of CN¥92.5m falling due after that. On the other hand, it had cash of CN¥1.83b and CN¥1.01b worth of receivables due within a year. So it actually has CN¥496.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Baoxiniao Holding could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Baoxiniao Holding has more cash than debt is arguably a good indication that it can manage its debt safely.

While Baoxiniao Holding doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Baoxiniao Holding's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Baoxiniao Holding 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, Baoxiniao Holding recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Baoxiniao Holding has CN¥1.11b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥579m, being 87% of its EBIT. So is Baoxiniao Holding's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Baoxiniao Holding that you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.