David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, China Baofeng (International) Limited (HKG:3966) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for China Baofeng (International)
What Is China Baofeng (International)'s Debt?
The image below, which you can click on for greater detail, shows that at June 2019 China Baofeng (International) had debt of CN¥1.71b, up from CN¥210.9m in one year. On the flip side, it has CN¥376.6m in cash leading to net debt of about CN¥1.33b.
How Strong Is China Baofeng (International)'s Balance Sheet?
The latest balance sheet data shows that China Baofeng (International) had liabilities of CN¥988.9m due within a year, and liabilities of CN¥1.70b falling due after that. On the other hand, it had cash of CN¥376.6m and CN¥1.59b worth of receivables due within a year. So it has liabilities totalling CN¥722.8m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since China Baofeng (International) has a market capitalization of CN¥1.46b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.