China Boqi Environmental (Holding) (HKG:2377) Seems To Use Debt Quite Sensibly

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. We note that China Boqi Environmental (Holding) Co., Ltd. (HKG:2377) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for China Boqi Environmental (Holding)

What Is China Boqi Environmental (Holding)'s Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 China Boqi Environmental (Holding) had CN¥216.3m of debt, an increase on CN¥174.1m, over one year. But it also has CN¥590.6m in cash to offset that, meaning it has CN¥374.3m net cash.

A Look At China Boqi Environmental (Holding)'s Liabilities

Zooming in on the latest balance sheet data, we can see that China Boqi Environmental (Holding) had liabilities of CN¥1.80b due within 12 months and liabilities of CN¥152.9m due beyond that. On the other hand, it had cash of CN¥590.6m and CN¥1.95b worth of receivables due within a year. So it actually has CN¥589.2m more liquid assets than total liabilities.

This excess liquidity is a great indication that China Boqi Environmental (Holding)'s balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that China Boqi Environmental (Holding) has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that China Boqi Environmental (Holding) has increased its EBIT by 8.7% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China Boqi Environmental (Holding)'s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While China Boqi Environmental (Holding) 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, China Boqi Environmental (Holding) burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Boqi Environmental (Holding) has CN¥374.3m in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 8.7% in the last twelve months. So is China Boqi Environmental (Holding)'s debt a risk? It doesn't seem so to us. 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 3 warning signs for China Boqi Environmental (Holding) (1 makes us a bit uncomfortable) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.

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