These 4 Measures Indicate That Anhui Yingliu Electromechanical (SHSE:603308) Is Using Debt Extensively

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Anhui Yingliu Electromechanical Co., Ltd. (SHSE:603308) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Anhui Yingliu Electromechanical

What Is Anhui Yingliu Electromechanical's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Anhui Yingliu Electromechanical had debt of CN¥4.50b, up from CN¥3.90b in one year. However, it also had CN¥635.6m in cash, and so its net debt is CN¥3.86b.

How Strong Is Anhui Yingliu Electromechanical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Anhui Yingliu Electromechanical had liabilities of CN¥2.99b due within 12 months and liabilities of CN¥3.39b due beyond that. Offsetting this, it had CN¥635.6m in cash and CN¥1.25b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.49b.

This deficit is considerable relative to its market capitalization of CN¥6.97b, so it does suggest shareholders should keep an eye on Anhui Yingliu Electromechanical's use of debt. 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.

Anhui Yingliu Electromechanical has a rather high debt to EBITDA ratio of 6.6 which suggests a meaningful debt load. However, its interest coverage of 3.0 is reasonably strong, which is a good sign. 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. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding 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

On the face of it, Anhui Yingliu Electromechanical's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Anhui Yingliu Electromechanical's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Anhui Yingliu Electromechanical is showing 3 warning signs in our investment analysis , and 1 of those can't be ignored...

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.