BAIC Motor (HKG:1958) Takes On Some Risk With Its Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 BAIC Motor Corporation Limited (HKG:1958) makes use of debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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, 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 BAIC Motor

How Much Debt Does BAIC Motor Carry?

As you can see below, BAIC Motor had CN¥5.70b of debt at September 2024, down from CN¥10.3b a year prior. However, its balance sheet shows it holds CN¥35.6b in cash, so it actually has CN¥29.9b net cash.

How Healthy Is BAIC Motor's Balance Sheet?

The latest balance sheet data shows that BAIC Motor had liabilities of CN¥77.8b due within a year, and liabilities of CN¥9.02b falling due after that. Offsetting these obligations, it had cash of CN¥35.6b as well as receivables valued at CN¥18.9b due within 12 months. So it has liabilities totalling CN¥32.4b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥17.0b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, BAIC Motor would likely require a major re-capitalisation if it had to pay its creditors today. Given that BAIC Motor has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

In fact BAIC Motor's saving grace is its low debt levels, because its EBIT has tanked 34% in the last twelve months. 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 future earnings, more than anything, that will determine BAIC Motor'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While BAIC Motor has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, BAIC Motor generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

Although BAIC Motor's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥29.9b. The cherry on top was that in converted 83% of that EBIT to free cash flow, bringing in CN¥10b. Despite the cash, we do find BAIC Motor's level of total liabilities concerning, so we're not particularly comfortable with the stock. 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. For example, we've discovered 2 warning signs for BAIC Motor that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.