Is China Boqi Environmental (Holding) (HKG:2377) A Risky Investment?

Warren Buffett famously said, '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. We can see that China Boqi Environmental (Holding) Co., Ltd. (HKG:2377) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for China Boqi Environmental (Holding)

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

The image below, which you can click on for greater detail, shows that China Boqi Environmental (Holding) had debt of CN¥174.1m at the end of December 2022, a reduction from CN¥195.7m over a year. But on the other hand it also has CN¥714.7m in cash, leading to a CN¥540.6m net cash position.

How Strong Is China Boqi Environmental (Holding)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Boqi Environmental (Holding) had liabilities of CN¥1.73b due within 12 months and liabilities of CN¥143.9m due beyond that. Offsetting these obligations, it had cash of CN¥714.7m as well as receivables valued at CN¥1.58b due within 12 months. So it can boast CN¥413.4m more liquid assets than total liabilities.

This surplus strongly suggests that China Boqi Environmental (Holding) has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, China Boqi Environmental (Holding) boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that China Boqi Environmental (Holding) has seen its EBIT plunge 12% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. 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. Considering the last three years, China Boqi Environmental (Holding) actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Boqi Environmental (Holding) has CN¥540.6m in net cash and a decent-looking balance sheet. So we don't have any problem with China Boqi Environmental (Holding)'s use of 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. We've identified 3 warning signs with China Boqi Environmental (Holding) , and understanding them should be part of your investment process.

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.