The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Bohai Automotive Systems CO., LTD. (SHSE:600960) makes use of debt. But should shareholders be worried about its use of debt?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Bohai Automotive Systems's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Bohai Automotive Systems had debt of CN¥1.67b, up from CN¥1.48b in one year. However, it also had CN¥819.9m in cash, and so its net debt is CN¥854.5m.
How Strong Is Bohai Automotive Systems' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Bohai Automotive Systems had liabilities of CN¥2.31b due within 12 months and liabilities of CN¥637.5m due beyond that. Offsetting this, it had CN¥819.9m in cash and CN¥1.51b in receivables that were due within 12 months. So it has liabilities totalling CN¥613.9m more than its cash and near-term receivables, combined.
Given Bohai Automotive Systems has a market capitalization of CN¥3.72b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Bohai Automotive Systems will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Bohai Automotive Systems reported revenue of CN¥4.6b, which is a gain of 15%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.
Caveat Emptor
Importantly, Bohai Automotive Systems had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥105m. 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. We would feel better if it turned its trailing twelve month loss of CN¥117m into a profit. So we do think this stock is quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Bohai Automotive Systems you should be aware of, and 1 of them is a bit unpleasant.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.
