Is Bao Shen Holdings (HKG:8151) Using Debt In A Risky Way?

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.' 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 note that Bao Shen Holdings Limited (HKG:8151) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Bao Shen Holdings

What Is Bao Shen Holdings's Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Bao Shen Holdings had debt of CN¥36.8m, up from CN¥27.7m in one year. However, its balance sheet shows it holds CN¥43.1m in cash, so it actually has CN¥6.36m net cash.

A Look At Bao Shen Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Bao Shen Holdings had liabilities of CN¥75.4m due within 12 months and liabilities of CN¥4.10m due beyond that. Offsetting these obligations, it had cash of CN¥43.1m as well as receivables valued at CN¥50.7m due within 12 months. So it can boast CN¥14.4m more liquid assets than total liabilities.

This luscious liquidity implies that Bao Shen Holdings' balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Bao Shen Holdings has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is Bao Shen Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Bao Shen Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 41%, to CN¥141m. With any luck the company will be able to grow its way to profitability.

So How Risky Is Bao Shen Holdings?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Bao Shen Holdings lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through CN¥8.2m of cash and made a loss of CN¥2.6m. Given it only has net cash of CN¥6.36m, the company may need to raise more capital if it doesn't reach break-even soon. With very solid revenue growth in the last year, Bao Shen Holdings may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. 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. To that end, you should learn about the 4 warning signs we've spotted with Bao Shen Holdings (including 3 which are concerning) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.
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