Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, BAIC Motor Corporation Limited (HKG:1958) is in debt. But should shareholders worry about its use of debt?
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, many companies use debt to finance their 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 BAIC Motor
What is BAIC Motor’s debt?
The image below, which you can click for more details, shows that BAIC Motor had a debt of 13.4 billion CN yen at the end of March 2022, a reduction from 17.6 billion of CN yen over one year. However, his balance sheet shows that he holds 40.3 billion yen in cash, so he actually has 26.9 billion yen in cash.
How healthy is BAIC Motor’s balance sheet?
The latest balance sheet data shows that BAIC Motor had liabilities of 81.8 billion yen maturing within one year, and liabilities of 13.7 billion yen maturing thereafter. In return, he had 40.3 billion Canadian yen in cash and 17.6 billion domestic yen in debt due within 12 months. It therefore has liabilities totaling 37.6 billion Canadian yen more than its cash and short-term receivables, combined.
This deficit casts a shadow over the CN¥17.6b company, like a colossus towering above mere mortals. We would therefore be watching his balance sheet closely, no doubt. Ultimately, BAIC Motor would likely need a major recapitalization if its creditors were to demand repayment. Since BAIC Motor has more cash than debt, we are quite confident that it can manage its debt, despite having a lot of debt in total.
Fortunately, BAIC Motor’s burden is not too heavy, as its EBIT fell by 21% compared to last year. When it comes to paying off debt, lower income is no more helpful than sugary sodas for your health. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether BAIC Motor can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. Although BAIC Motor has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) to free cash flow, to help us understand how fast it’s building ( or erodes) this treasury. balance. Over the past three years, BAIC Motor has recorded free cash flow of 55% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Although BAIC Motor’s balance sheet is not particularly strong, due to total liabilities, it is clearly positive to see that it has a net cash position of 26.9 billion Canadian yen. Despite the money, we find BAIC Motor’s level of total liabilities concerning, so we’re not particularly comfortable with the stock. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. For example, we found 1 x BAIC Engine Warning Sign which you should be aware of before investing here.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.