Baolong International (TPE:1906) Is Making Moderate Use Of Debt

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Baolong International Co., Ltd. (TPE:1906) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Baolong International

How Much Debt Does Baolong International Carry?

You can click the graphic below for the historical numbers, but it shows that Baolong International had NT$1.36b of debt in September 2020, down from NT$1.49b, one year before. And it doesn't have much cash, so its net debt is about the same.

How Strong Is Baolong International's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Baolong International had liabilities of NT$1.55b due within 12 months and liabilities of NT$321.4m due beyond that. Offsetting this, it had NT$10.0m in cash and NT$130.5m in receivables that were due within 12 months. So its liabilities total NT$1.73b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of NT$2.68b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Baolong International's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Baolong International saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.

Caveat Emptor

Over the last twelve months Baolong International produced an earnings before interest and tax (EBIT) loss. Indeed, it lost NT$11m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Surprisingly, we note that it actually reported positive free cash flow of NT$142m and a profit of NT$76m. So one might argue that there's still a chance it can get things on the right track. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Baolong International (including 1 which is concerning) .

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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