We Think Shandong Boan Biotechnology (HKG:6955) Is Taking Some Risk With Its Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Shandong Boan Biotechnology Co., Ltd. (HKG:6955) does use debt in its business. But should shareholders be worried about its use of debt?

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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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Shandong Boan Biotechnology Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Shandong Boan Biotechnology had CN¥678.9m of debt, an increase on CN¥396.2m, over one year. However, because it has a cash reserve of CN¥198.9m, its net debt is less, at about CN¥480.1m.

A Look At Shandong Boan Biotechnology's Liabilities

According to the last reported balance sheet, Shandong Boan Biotechnology had liabilities of CN¥648.7m due within 12 months, and liabilities of CN¥558.6m due beyond 12 months. On the other hand, it had cash of CN¥198.9m and CN¥514.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥494.3m.

Given Shandong Boan Biotechnology has a market capitalization of CN¥5.31b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

View our latest analysis for Shandong Boan Biotechnology

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about Shandong Boan Biotechnology's net debt to EBITDA ratio of 4.6, we think its super-low interest cover of 1.9 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. One redeeming factor for Shandong Boan Biotechnology is that it turned last year's EBIT loss into a gain of CN¥61m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shandong Boan Biotechnology can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept 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, Shandong Boan Biotechnology burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Shandong Boan Biotechnology's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its level of total liabilities is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Shandong Boan Biotechnology's debt is making it 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. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Shandong Boan Biotechnology you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.