We Think Jiangsu Yike Food GroupLtd (SZSE:301116) Can Stay On Top Of Its Debt

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Jiangsu Yike Food Group Co.,Ltd (SZSE:301116) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Jiangsu Yike Food GroupLtd

How Much Debt Does Jiangsu Yike Food GroupLtd Carry?

You can click the graphic below for the historical numbers, but it shows that Jiangsu Yike Food GroupLtd had CN¥1.26b of debt in September 2024, down from CN¥1.41b, one year before. However, because it has a cash reserve of CN¥611.4m, its net debt is less, at about CN¥648.9m.

How Strong Is Jiangsu Yike Food GroupLtd's Balance Sheet?

We can see from the most recent balance sheet that Jiangsu Yike Food GroupLtd had liabilities of CN¥2.26b falling due within a year, and liabilities of CN¥858.9m due beyond that. Offsetting this, it had CN¥611.4m in cash and CN¥383.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.12b.

This deficit isn't so bad because Jiangsu Yike Food GroupLtd is worth CN¥6.55b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Given net debt is only 1.3 times EBITDA, it is initially surprising to see that Jiangsu Yike Food GroupLtd's EBIT has low interest coverage of 2.0 times. So one way or the other, it's clear the debt levels are not trivial. Notably Jiangsu Yike Food GroupLtd's EBIT was pretty flat over the last year. We would prefer to see some earnings growth, because that always helps diminish debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Jiangsu Yike Food GroupLtd'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Jiangsu Yike Food GroupLtd recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Jiangsu Yike Food GroupLtd's interest cover was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we thought its conversion of EBIT to free cash flow was a positive. Looking at all this data makes us feel a little cautious about Jiangsu Yike Food GroupLtd's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 Jiangsu Yike Food GroupLtd (at least 1 which is potentially serious) , 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.