Is Bestlink TechnologiesLtd (SHSE:603206) Using Too Much Debt?

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.' 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 Bestlink Technologies Co.,Ltd. (SHSE:603206) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Bestlink TechnologiesLtd

What Is Bestlink TechnologiesLtd's Net Debt?

As you can see below, at the end of September 2023, Bestlink TechnologiesLtd had CN¥749.4m of debt, up from CN¥145.7m a year ago. Click the image for more detail. On the flip side, it has CN¥668.3m in cash leading to net debt of about CN¥81.1m.

How Healthy Is Bestlink TechnologiesLtd's Balance Sheet?

The latest balance sheet data shows that Bestlink TechnologiesLtd had liabilities of CN¥3.02b due within a year, and liabilities of CN¥8.28m falling due after that. On the other hand, it had cash of CN¥668.3m and CN¥1.62b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥748.6m.

Of course, Bestlink TechnologiesLtd has a market capitalization of CN¥4.88b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Bestlink TechnologiesLtd's net debt is only 0.40 times its EBITDA. And its EBIT covers its interest expense a whopping 222 times over. So we're pretty relaxed about its super-conservative use of debt. But the bad news is that Bestlink TechnologiesLtd has seen its EBIT plunge 19% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is Bestlink TechnologiesLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Bestlink TechnologiesLtd 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

While Bestlink TechnologiesLtd's conversion of EBIT to free cash flow has us nervous. For example, its interest cover and net debt to EBITDA give us some confidence in its ability to manage its debt. When we consider all the factors discussed, it seems to us that Bestlink TechnologiesLtd is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Bestlink TechnologiesLtd (1 is concerning!) that you should be aware of before investing here.

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.