Does Baguio Green Group (HKG:1397) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Baguio Green Group Limited (HKG:1397) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Baguio Green Group

What Is Baguio Green Group's Net Debt?

As you can see below, at the end of June 2022, Baguio Green Group had HK$158.9m of debt, up from HK$130.3m a year ago. Click the image for more detail. On the flip side, it has HK$43.4m in cash leading to net debt of about HK$115.4m.

How Strong Is Baguio Green Group's Balance Sheet?

The latest balance sheet data shows that Baguio Green Group had liabilities of HK$401.0m due within a year, and liabilities of HK$66.8m falling due after that. Offsetting these obligations, it had cash of HK$43.4m as well as receivables valued at HK$334.2m due within 12 months. So its liabilities total HK$90.2m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Baguio Green Group has a market capitalization of HK$211.7m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Baguio Green Group has net debt worth 1.8 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 4.5 times the interest expense. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. We also note that Baguio Green Group improved its EBIT from a last year's loss to a positive HK$24m. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Baguio Green Group'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. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Baguio Green Group 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

We'd go so far as to say Baguio Green Group's conversion of EBIT to free cash flow was disappointing. But at least its net debt to EBITDA is not so bad. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Baguio Green Group stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. Case in point: We've spotted 3 warning signs for Baguio Green Group you should be aware of.

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.