We Think Beijing Bohui Innovation Biotechnology Group (SZSE:300318) Is Taking Some Risk With Its 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.' 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, Beijing Bohui Innovation Biotechnology Group Co., Ltd. (SZSE:300318) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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.

View our latest analysis for Beijing Bohui Innovation Biotechnology Group

How Much Debt Does Beijing Bohui Innovation Biotechnology Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Beijing Bohui Innovation Biotechnology Group had CN¥926.4m of debt, an increase on CN¥774.6m, over one year. However, it also had CN¥93.8m in cash, and so its net debt is CN¥832.7m.

How Strong Is Beijing Bohui Innovation Biotechnology Group's Balance Sheet?

We can see from the most recent balance sheet that Beijing Bohui Innovation Biotechnology Group had liabilities of CN¥1.04b falling due within a year, and liabilities of CN¥577.2m due beyond that. Offsetting these obligations, it had cash of CN¥93.8m as well as receivables valued at CN¥134.1m due within 12 months. So it has liabilities totalling CN¥1.39b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Beijing Bohui Innovation Biotechnology Group has a market capitalization of CN¥4.33b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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).

Beijing Bohui Innovation Biotechnology Group's debt is 4.0 times its EBITDA, and its EBIT cover its interest expense 4.9 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. We also note that Beijing Bohui Innovation Biotechnology Group improved its EBIT from a last year's loss to a positive CN¥111m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Beijing Bohui Innovation Biotechnology Group'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 the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Beijing Bohui Innovation Biotechnology Group saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Mulling over Beijing Bohui Innovation Biotechnology Group's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. Having said that, its ability to grow its EBIT isn't such a worry. We should also note that Medical Equipment industry companies like Beijing Bohui Innovation Biotechnology Group commonly do use debt without problems. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Beijing Bohui Innovation Biotechnology Group stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Beijing Bohui Innovation Biotechnology Group 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.

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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.