Here's Why BGI Genomics (SZSE:300676) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that BGI Genomics Co., Ltd. (SZSE:300676) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

View our latest analysis for BGI Genomics

What Is BGI Genomics's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 BGI Genomics had CN¥292.7m of debt, an increase on none, over one year. But it also has CN¥5.55b in cash to offset that, meaning it has CN¥5.25b net cash.

How Strong Is BGI Genomics' Balance Sheet?

The latest balance sheet data shows that BGI Genomics had liabilities of CN¥3.04b due within a year, and liabilities of CN¥333.9m falling due after that. Offsetting this, it had CN¥5.55b in cash and CN¥1.63b in receivables that were due within 12 months. So it can boast CN¥3.81b more liquid assets than total liabilities.

This excess liquidity suggests that BGI Genomics is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, BGI Genomics boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for BGI Genomics if management cannot prevent a repeat of the 81% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is BGI Genomics'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. BGI Genomics may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Considering the last three years, BGI Genomics actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case BGI Genomics has CN¥5.25b in net cash and a decent-looking balance sheet. So we are not troubled with BGI Genomics's debt use. 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. Be aware that BGI Genomics is showing 3 warning signs in our investment analysis , and 2 of those are a bit unpleasant...

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.