China Bester Group Telecom (SHSE:603220) Takes On Some Risk With Its Use Of Debt

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. Importantly, China Bester Group Telecom Co., Ltd. (SHSE:603220) does carry debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for China Bester Group Telecom

What Is China Bester Group Telecom's Debt?

As you can see below, at the end of September 2024, China Bester Group Telecom had CN¥2.75b of debt, up from CN¥1.25b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥359.0m, its net debt is less, at about CN¥2.40b.

How Healthy Is China Bester Group Telecom's Balance Sheet?

We can see from the most recent balance sheet that China Bester Group Telecom had liabilities of CN¥3.49b falling due within a year, and liabilities of CN¥2.07b due beyond that. Offsetting this, it had CN¥359.0m in cash and CN¥2.55b in receivables that were due within 12 months. So its liabilities total CN¥2.65b more than the combination of its cash and short-term receivables.

China Bester Group Telecom has a market capitalization of CN¥8.67b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

China Bester Group Telecom has a rather high debt to EBITDA ratio of 6.8 which suggests a meaningful debt load. However, its interest coverage of 3.2 is reasonably strong, which is a good sign. Looking on the bright side, China Bester Group Telecom boosted its EBIT by a silky 67% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. There's no doubt that we learn most about debt from the balance sheet. But it is China Bester Group Telecom'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, China Bester Group Telecom burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither China Bester Group Telecom's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that China Bester Group Telecom is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for China Bester Group Telecom you should know about.

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.