Is BYD Electronic (International) (HKG:285) Using Too Much Debt?

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. Importantly, BYD Electronic (International) Company Limited (HKG:285) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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 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 BYD Electronic (International)

What Is BYD Electronic (International)'s Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 BYD Electronic (International) had CN¥2.00b of debt, an increase on none, over one year. But it also has CN¥7.54b in cash to offset that, meaning it has CN¥5.54b net cash.

A Look At BYD Electronic (International)'s Liabilities

According to the last reported balance sheet, BYD Electronic (International) had liabilities of CN¥30.1b due within 12 months, and liabilities of CN¥1.22b due beyond 12 months. On the other hand, it had cash of CN¥7.54b and CN¥15.8b worth of receivables due within a year. So it has liabilities totalling CN¥8.00b more than its cash and near-term receivables, combined.

Of course, BYD Electronic (International) has a market capitalization of CN¥45.8b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, BYD Electronic (International) boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that BYD Electronic (International)'s load is not too heavy, because its EBIT was down 57% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 BYD Electronic (International)'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While BYD Electronic (International) 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. Over the most recent three years, BYD Electronic (International) recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While BYD Electronic (International) does have more liabilities than liquid assets, it also has net cash of CN¥5.54b. So we don't have any problem with BYD Electronic (International)'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. To that end, you should be aware of the 1 warning sign we've spotted with BYD Electronic (International) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.