Is Guangdong Yuehai Feeds GroupLtd (SZSE:001313) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Guangdong Yuehai Feeds Group Co.,Ltd. (SZSE:001313) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Guangdong Yuehai Feeds GroupLtd

What Is Guangdong Yuehai Feeds GroupLtd's Net Debt?

As you can see below, Guangdong Yuehai Feeds GroupLtd had CN¥953.6m of debt at March 2024, down from CN¥1.27b a year prior. However, because it has a cash reserve of CN¥942.0m, its net debt is less, at about CN¥11.6m.

How Healthy Is Guangdong Yuehai Feeds GroupLtd's Balance Sheet?

According to the last reported balance sheet, Guangdong Yuehai Feeds GroupLtd had liabilities of CN¥1.95b due within 12 months, and liabilities of CN¥170.0m due beyond 12 months. Offsetting these obligations, it had cash of CN¥942.0m as well as receivables valued at CN¥1.36b due within 12 months. So it actually has CN¥179.7m more liquid assets than total liabilities.

This surplus suggests that Guangdong Yuehai Feeds GroupLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Carrying virtually no net debt, Guangdong Yuehai Feeds GroupLtd has a very light debt load indeed.

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).

Guangdong Yuehai Feeds GroupLtd's debt of just 0.077 times EBITDA is clearly modest. But EBIT was only 1.5 times the interest expense last year, which shows that the debt has negatively impacted the business, by constraining its options (and restricting its free cash flow). Shareholders should be aware that Guangdong Yuehai Feeds GroupLtd's EBIT was down 50% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Guangdong Yuehai Feeds GroupLtd can strengthen its balance sheet over time. 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, Guangdong Yuehai Feeds GroupLtd saw substantial negative free cash flow, in total. 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 Guangdong Yuehai Feeds GroupLtd's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Guangdong Yuehai Feeds GroupLtd'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. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Guangdong Yuehai Feeds GroupLtd you should know about.

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.