These 4 Measures Indicate That Yuan Long Ping High-Tech Agriculture (SZSE:000998) Is Using Debt Extensively

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Yuan Long Ping High-Tech Agriculture Co., Ltd. (SZSE:000998) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Yuan Long Ping High-Tech Agriculture

What Is Yuan Long Ping High-Tech Agriculture's Debt?

As you can see below, at the end of March 2024, Yuan Long Ping High-Tech Agriculture had CN¥11.8b of debt, up from CN¥5.85b a year ago. Click the image for more detail. However, it does have CN¥3.45b in cash offsetting this, leading to net debt of about CN¥8.33b.

How Strong Is Yuan Long Ping High-Tech Agriculture's Balance Sheet?

We can see from the most recent balance sheet that Yuan Long Ping High-Tech Agriculture had liabilities of CN¥10.9b falling due within a year, and liabilities of CN¥6.04b due beyond that. Offsetting this, it had CN¥3.45b in cash and CN¥2.68b in receivables that were due within 12 months. So it has liabilities totalling CN¥10.8b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥11.8b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). 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).

Weak interest cover of 1.7 times and a disturbingly high net debt to EBITDA ratio of 6.2 hit our confidence in Yuan Long Ping High-Tech Agriculture like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Looking on the bright side, Yuan Long Ping High-Tech Agriculture boosted its EBIT by a silky 53% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. 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 Yuan Long Ping High-Tech Agriculture'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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last two years, Yuan Long Ping High-Tech Agriculture 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

To be frank both Yuan Long Ping High-Tech Agriculture's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Yuan Long Ping High-Tech Agriculture has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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 2 warning signs with Yuan Long Ping High-Tech Agriculture (at least 1 which is significant) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.