Is Gansu Yasheng Industrial (Group) (SHSE:600108) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Gansu Yasheng Industrial (Group) Co., Ltd. (SHSE:600108) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Gansu Yasheng Industrial (Group)

What Is Gansu Yasheng Industrial (Group)'s Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Gansu Yasheng Industrial (Group) had CN¥3.57b of debt, an increase on CN¥3.19b, over one year. On the flip side, it has CN¥390.1m in cash leading to net debt of about CN¥3.18b.

A Look At Gansu Yasheng Industrial (Group)'s Liabilities

According to the last reported balance sheet, Gansu Yasheng Industrial (Group) had liabilities of CN¥2.13b due within 12 months, and liabilities of CN¥2.87b due beyond 12 months. Offsetting these obligations, it had cash of CN¥390.1m as well as receivables valued at CN¥1.84b due within 12 months. So its liabilities total CN¥2.78b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Gansu Yasheng Industrial (Group) has a market capitalization of CN¥6.19b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Gansu Yasheng Industrial (Group) shareholders face the double whammy of a high net debt to EBITDA ratio (10.1), and fairly weak interest coverage, since EBIT is just 1.5 times the interest expense. This means we'd consider it to have a heavy debt load. Notably, Gansu Yasheng Industrial (Group)'s EBIT was pretty flat over the last year, which isn't ideal given the debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Gansu Yasheng Industrial (Group) 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Gansu Yasheng Industrial (Group) burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Gansu Yasheng Industrial (Group)'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. Having said that, its ability to grow its EBIT isn't such a worry. We're quite clear that we consider Gansu Yasheng Industrial (Group) to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 Gansu Yasheng Industrial (Group) is showing 2 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.