Anhui Yingliu Electromechanical (SHSE:603308) Takes On Some Risk With Its Use Of Debt

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 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, Anhui Yingliu Electromechanical Co., Ltd. (SHSE:603308) does carry debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Anhui Yingliu Electromechanical

How Much Debt Does Anhui Yingliu Electromechanical Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Anhui Yingliu Electromechanical had debt of CN¥4.73b, up from CN¥4.03b in one year. However, because it has a cash reserve of CN¥456.6m, its net debt is less, at about CN¥4.28b.

How Strong Is Anhui Yingliu Electromechanical's Balance Sheet?

The latest balance sheet data shows that Anhui Yingliu Electromechanical had liabilities of CN¥3.09b due within a year, and liabilities of CN¥3.46b falling due after that. Offsetting these obligations, it had cash of CN¥456.6m as well as receivables valued at CN¥1.31b due within 12 months. So it has liabilities totalling CN¥4.78b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Anhui Yingliu Electromechanical has a market capitalization of CN¥13.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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).

With a net debt to EBITDA ratio of 7.1, it's fair to say Anhui Yingliu Electromechanical does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 3.4 times, suggesting it can responsibly service its obligations. On a lighter note, we note that Anhui Yingliu Electromechanical grew its EBIT by 25% in the last year. If it can maintain that kind of improvement, its debt load will begin to melt away like glaciers in a warming world. 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 Anhui Yingliu Electromechanical'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Anhui Yingliu Electromechanical saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

While Anhui Yingliu Electromechanical's net debt to EBITDA makes us cautious about it, its track record of converting EBIT to free cash flow is no better. But at least its EBIT growth rate is a gleaming silver lining to those clouds. Taking the abovementioned factors together we do think Anhui Yingliu Electromechanical's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. We've identified 4 warning signs with Anhui Yingliu Electromechanical (at least 1 which is concerning) , 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.