We Think Shandong Yisheng Livestock & Poultry Breeding (SZSE:002458) Is Taking Some Risk With Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Shandong Yisheng Livestock & Poultry Breeding Co., Ltd. (SZSE:002458) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shandong Yisheng Livestock & Poultry Breeding

What Is Shandong Yisheng Livestock & Poultry Breeding's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shandong Yisheng Livestock & Poultry Breeding had CN¥1.78b of debt, an increase on CN¥1.11b, over one year. However, it also had CN¥1.27b in cash, and so its net debt is CN¥510.4m.

How Strong Is Shandong Yisheng Livestock & Poultry Breeding's Balance Sheet?

We can see from the most recent balance sheet that Shandong Yisheng Livestock & Poultry Breeding had liabilities of CN¥2.37b falling due within a year, and liabilities of CN¥308.5m due beyond that. On the other hand, it had cash of CN¥1.27b and CN¥73.1m worth of receivables due within a year. So its liabilities total CN¥1.33b more than the combination of its cash and short-term receivables.

Since publicly traded Shandong Yisheng Livestock & Poultry Breeding shares are worth a total of CN¥10.8b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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).

Looking at its net debt to EBITDA of 0.94 and interest cover of 6.6 times, it seems to us that Shandong Yisheng Livestock & Poultry Breeding is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. It is just as well that Shandong Yisheng Livestock & Poultry Breeding's load is not too heavy, because its EBIT was down 71% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shandong Yisheng Livestock & Poultry Breeding'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 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. Looking at the most recent two years, Shandong Yisheng Livestock & Poultry Breeding recorded free cash flow of 39% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Shandong Yisheng Livestock & Poultry Breeding's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example, its net debt to EBITDA is relatively strong. We think that Shandong Yisheng Livestock & Poultry Breeding's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. Be aware that Shandong Yisheng Livestock & Poultry Breeding is showing 3 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

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.

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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.