BOE Varitronix (HKG:710) Seems To Use Debt Quite Sensibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that BOE Varitronix Limited (HKG:710) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for BOE Varitronix

What Is BOE Varitronix's Net Debt?

As you can see below, at the end of June 2023, BOE Varitronix had HK$785.3m of debt, up from HK$46.8m a year ago. Click the image for more detail. However, its balance sheet shows it holds HK$2.36b in cash, so it actually has HK$1.57b net cash.

How Healthy Is BOE Varitronix's Balance Sheet?

According to the last reported balance sheet, BOE Varitronix had liabilities of HK$4.14b due within 12 months, and liabilities of HK$217.8m due beyond 12 months. Offsetting these obligations, it had cash of HK$2.36b as well as receivables valued at HK$2.60b due within 12 months. So it actually has HK$593.0m more liquid assets than total liabilities.

This short term liquidity is a sign that BOE Varitronix could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, BOE Varitronix boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that BOE Varitronix grew its EBIT at 13% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine BOE Varitronix's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. BOE Varitronix may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, BOE Varitronix 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.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that BOE Varitronix has net cash of HK$1.57b, as well as more liquid assets than liabilities. And it also grew its EBIT by 13% over the last year. So we don't have any problem with BOE Varitronix's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example BOE Varitronix has 3 warning signs (and 1 which is significant) we think you should know about.

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.