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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, BOE Technology Group Company Limited (SZSE:000725) does carry debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is BOE Technology Group's Net Debt?

As you can see below, BOE Technology Group had CN¥145.8b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of CN¥90.6b, its net debt is less, at about CN¥55.1b.

How Strong Is BOE Technology Group's Balance Sheet?

We can see from the most recent balance sheet that BOE Technology Group had liabilities of CN¥99.8b falling due within a year, and liabilities of CN¥122.1b due beyond that. Offsetting this, it had CN¥90.6b in cash and CN¥34.6b in receivables that were due within 12 months. So its liabilities total CN¥96.6b more than the combination of its cash and short-term receivables.

This is a mountain of leverage even relative to its gargantuan market capitalization of CN¥153.4b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Given net debt is only 1.5 times EBITDA, it is initially surprising to see that BOE Technology Group's EBIT has low interest coverage of 1.1 times. So one way or the other, it's clear the debt levels are not trivial. Notably, BOE Technology Group made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥1.5b in the last twelve months. 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 Technology Group'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, BOE Technology Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Based on what we've seen BOE Technology Group is not finding it easy, given its interest cover, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its conversion of EBIT to free cash flow. Looking at all this data makes us feel a little cautious about BOE Technology Group's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with BOE Technology Group .

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.