We Think Henan Yuguang Gold&LeadLtd (SHSE:600531) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Henan Yuguang Gold&Lead Co.,Ltd. (SHSE:600531) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for Henan Yuguang Gold&LeadLtd

How Much Debt Does Henan Yuguang Gold&LeadLtd Carry?

As you can see below, at the end of March 2024, Henan Yuguang Gold&LeadLtd had CN¥8.66b of debt, up from CN¥7.34b a year ago. Click the image for more detail. On the flip side, it has CN¥2.02b in cash leading to net debt of about CN¥6.64b.

A Look At Henan Yuguang Gold&LeadLtd's Liabilities

We can see from the most recent balance sheet that Henan Yuguang Gold&LeadLtd had liabilities of CN¥9.65b falling due within a year, and liabilities of CN¥1.58b due beyond that. Offsetting this, it had CN¥2.02b in cash and CN¥950.4m in receivables that were due within 12 months. So its liabilities total CN¥8.26b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥7.20b, we think shareholders really should watch Henan Yuguang Gold&LeadLtd's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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

With a net debt to EBITDA ratio of 5.8, it's fair to say Henan Yuguang Gold&LeadLtd does have a significant amount of debt. However, its interest coverage of 6.0 is reasonably strong, which is a good sign. Notably, Henan Yuguang Gold&LeadLtd's EBIT launched higher than Elon Musk, gaining a whopping 247% on last year. There's no doubt that we learn most about debt from the balance sheet. But it is Henan Yuguang Gold&LeadLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Henan Yuguang Gold&LeadLtd 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

On the face of it, Henan Yuguang Gold&LeadLtd's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. Looking at the bigger picture, it seems clear to us that Henan Yuguang Gold&LeadLtd's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Henan Yuguang Gold&LeadLtd has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.