These 4 Measures Indicate That Yantai Eddie Precision Machinery (SHSE:603638) Is Using Debt Reasonably Well

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Yantai Eddie Precision Machinery Co., Ltd. (SHSE:603638) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

View our latest analysis for Yantai Eddie Precision Machinery

How Much Debt Does Yantai Eddie Precision Machinery Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Yantai Eddie Precision Machinery had CN¥1.55b of debt, an increase on CN¥1.18b, over one year. However, it does have CN¥936.9m in cash offsetting this, leading to net debt of about CN¥618.0m.

A Look At Yantai Eddie Precision Machinery's Liabilities

The latest balance sheet data shows that Yantai Eddie Precision Machinery had liabilities of CN¥1.58b due within a year, and liabilities of CN¥1.00b falling due after that. Offsetting this, it had CN¥936.9m in cash and CN¥1.16b in receivables that were due within 12 months. So its liabilities total CN¥484.8m more than the combination of its cash and short-term receivables.

Given Yantai Eddie Precision Machinery has a market capitalization of CN¥12.7b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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 net debt sitting at just 1.1 times EBITDA, Yantai Eddie Precision Machinery is arguably pretty conservatively geared. And it boasts interest cover of 8.1 times, which is more than adequate. Also positive, Yantai Eddie Precision Machinery grew its EBIT by 20% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Yantai Eddie Precision Machinery's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Yantai Eddie Precision Machinery recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Yantai Eddie Precision Machinery's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its EBIT growth rate. When we consider all the elements mentioned above, it seems to us that Yantai Eddie Precision Machinery is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Yantai Eddie Precision Machinery's earnings per share history for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.