Is BAIC Motor (HKG:1958) Using Too Much 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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies BAIC Motor Corporation Limited (HKG:1958) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for BAIC Motor

What Is BAIC Motor's Net Debt?

As you can see below, BAIC Motor had CN¥20.3b of debt at December 2022, down from CN¥22.4b a year prior. However, its balance sheet shows it holds CN¥37.2b in cash, so it actually has CN¥16.9b net cash.

How Healthy Is BAIC Motor's Balance Sheet?

We can see from the most recent balance sheet that BAIC Motor had liabilities of CN¥79.3b falling due within a year, and liabilities of CN¥15.1b due beyond that. Offsetting this, it had CN¥37.2b in cash and CN¥18.1b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥39.2b.

The deficiency here weighs heavily on the CN¥15.1b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. 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.

And we also note warmly that BAIC Motor grew its EBIT by 13% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if BAIC Motor can strengthen its balance sheet over time. 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. BAIC Motor 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. Over the most recent three years, BAIC Motor recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

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¥16.9b. And it impressed us with free cash flow of CN¥31b, being 69% of its EBIT. So we are not troubled with BAIC Motor's debt use. 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. For instance, we've identified 1 warning sign for BAIC Motor that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.