These 4 Measures Indicate That BAIC Motor (HKG:1958) Is Using Debt Reasonably Well

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.' 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. We can see that BAIC Motor Corporation Limited (HKG:1958) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for BAIC Motor

How Much Debt Does BAIC Motor Carry?

The image below, which you can click on for greater detail, shows that BAIC Motor had debt of CN¥11.5b at the end of March 2023, a reduction from CN¥13.4b over a year. But it also has CN¥38.2b in cash to offset that, meaning it has CN¥26.7b net cash.

How Strong Is BAIC Motor's Balance Sheet?

The latest balance sheet data shows that BAIC Motor had liabilities of CN¥77.1b due within a year, and liabilities of CN¥14.2b falling due after that. On the other hand, it had cash of CN¥38.2b and CN¥18.4b worth of receivables due within a year. So its liabilities total CN¥34.6b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥14.3b 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. BAIC Motor boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Also good is that BAIC Motor grew its EBIT at 16% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. 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 company can only pay off debt with cold hard cash, not accounting profits. 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 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While BAIC Motor does have more liabilities than liquid assets, it also has net cash of CN¥26.7b. And it impressed us with its EBIT growth of 16% over the last year. So we are not troubled with BAIC Motor's debt use. 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 BAIC Motor (1 is a bit concerning!) 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.

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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.