Is BrightGene Bio-Medical Technology (SHSE:688166) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies BrightGene Bio-Medical Technology Co., Ltd. (SHSE:688166) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for BrightGene Bio-Medical Technology

How Much Debt Does BrightGene Bio-Medical Technology Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 BrightGene Bio-Medical Technology had CN¥2.36b of debt, an increase on CN¥2.08b, over one year. However, it does have CN¥954.2m in cash offsetting this, leading to net debt of about CN¥1.40b.

How Healthy Is BrightGene Bio-Medical Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that BrightGene Bio-Medical Technology had liabilities of CN¥1.01b due within 12 months and liabilities of CN¥1.80b due beyond that. On the other hand, it had cash of CN¥954.2m and CN¥341.8m worth of receivables due within a year. So it has liabilities totalling CN¥1.52b more than its cash and near-term receivables, combined.

Given BrightGene Bio-Medical Technology has a market capitalization of CN¥10.5b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

With a net debt to EBITDA ratio of 5.2, it's fair to say BrightGene Bio-Medical Technology does have a significant amount of debt. However, its interest coverage of 6.2 is reasonably strong, which is a good sign. Shareholders should be aware that BrightGene Bio-Medical Technology's EBIT was down 26% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 BrightGene Bio-Medical Technology's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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 three years, BrightGene Bio-Medical Technology 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

To be frank both BrightGene Bio-Medical Technology's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least its interest cover is not so bad. Overall, we think it's fair to say that BrightGene Bio-Medical Technology has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. Case in point: We've spotted 2 warning signs for BrightGene Bio-Medical Technology 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.