Is BOE Varitronix (HKG:710) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for BOE Varitronix

What Is BOE Varitronix's 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. But it also has HK$2.36b in cash to offset that, meaning it has HK$1.57b net cash.

How Healthy Is BOE Varitronix's Balance Sheet?

The latest balance sheet data shows that BOE Varitronix had liabilities of HK$4.14b due within a year, and liabilities of HK$217.8m falling due after that. On the other hand, it had cash of HK$2.36b and HK$2.60b worth of receivables due within a year. So it can boast 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. Simply put, the fact that BOE Varitronix has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that BOE Varitronix grew its EBIT by 13% last year, making its debt load easier to handle. 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 BOE Varitronix'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While BOE Varitronix 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 last three years, BOE Varitronix saw substantial negative free cash flow, in total. 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. On top of that, it increased its EBIT by 13% in the last twelve months. So we are not troubled with BOE Varitronix's debt use. 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. Be aware that BOE Varitronix is showing 3 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.