Is Yihai Kerry Arawana Holdings (SZSE:300999) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, Yihai Kerry Arawana Holdings Co., Ltd (SZSE:300999) does carry debt. But is this debt a concern to shareholders?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Yihai Kerry Arawana Holdings

What Is Yihai Kerry Arawana Holdings's Net Debt?

As you can see below, Yihai Kerry Arawana Holdings had CN¥94.3b of debt at June 2024, down from CN¥121.7b a year prior. However, it does have CN¥62.3b in cash offsetting this, leading to net debt of about CN¥32.0b.

A Look At Yihai Kerry Arawana Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Yihai Kerry Arawana Holdings had liabilities of CN¥108.9b due within 12 months and liabilities of CN¥7.57b due beyond that. On the other hand, it had cash of CN¥62.3b and CN¥12.9b worth of receivables due within a year. So its liabilities total CN¥41.3b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Yihai Kerry Arawana Holdings has a huge market capitalization of CN¥151.2b, 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 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

As it happens Yihai Kerry Arawana Holdings has a fairly concerning net debt to EBITDA ratio of 5.9 but very strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Pleasingly, Yihai Kerry Arawana Holdings is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 713% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Yihai Kerry Arawana Holdings'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Yihai Kerry Arawana Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Yihai Kerry Arawana Holdings's conversion of EBIT to free cash flow was a real negative on this analysis, as was its net debt to EBITDA. But like a ballerina ending on a perfect pirouette, it has not trouble covering its interest expense with its EBIT. When we consider all the factors mentioned above, we do feel a bit cautious about Yihai Kerry Arawana Holdings's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. Over time, share prices tend to follow earnings per share, so if you're interested in Yihai Kerry Arawana Holdings, you may well want to click here to check an interactive graph of its earnings per share history.

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.