Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Jiangxi Bestoo Energy Co.,Ltd. (SZSE:001376) makes use of debt. But is this debt a concern to shareholders?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Jiangxi Bestoo EnergyLtd's Debt?
As you can see below, Jiangxi Bestoo EnergyLtd had CN¥247.3m of debt at December 2023, down from CN¥258.1m a year prior. However, it also had CN¥188.3m in cash, and so its net debt is CN¥58.9m.
A Look At Jiangxi Bestoo EnergyLtd's Liabilities
Zooming in on the latest balance sheet data, we can see that Jiangxi Bestoo EnergyLtd had liabilities of CN¥409.2m due within 12 months and liabilities of CN¥47.7m due beyond that. Offsetting this, it had CN¥188.3m in cash and CN¥61.8m in receivables that were due within 12 months. So it has liabilities totalling CN¥206.9m more than its cash and near-term receivables, combined.
Given Jiangxi Bestoo EnergyLtd has a market capitalization of CN¥9.77b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. But either way, Jiangxi Bestoo EnergyLtd has virtually no net debt, so it's fair to say it does not have a heavy debt load!
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Jiangxi Bestoo EnergyLtd has a low net debt to EBITDA ratio of only 0.21. And its EBIT covers its interest expense a whopping 22.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that Jiangxi Bestoo EnergyLtd has been able to increase its EBIT by 21% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Jiangxi Bestoo EnergyLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Jiangxi Bestoo EnergyLtd recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Our View
The good news is that Jiangxi Bestoo EnergyLtd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its net debt to EBITDA also supports that impression! We would also note that Water Utilities industry companies like Jiangxi Bestoo EnergyLtd commonly do use debt without problems. Considering this range of factors, it seems to us that Jiangxi Bestoo EnergyLtd is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Jiangxi Bestoo EnergyLtd (at least 1 which can't be ignored) , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.