Does Tianjin You Fa Steel Pipe Group Stock (SHSE:601686) Have A Healthy Balance Sheet?

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 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, Tianjin You Fa Steel Pipe Group Stock Co., Ltd. (SHSE:601686) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Tianjin You Fa Steel Pipe Group Stock

What Is Tianjin You Fa Steel Pipe Group Stock's Debt?

The image below, which you can click on for greater detail, shows that Tianjin You Fa Steel Pipe Group Stock had debt of CN¥5.17b at the end of March 2024, a reduction from CN¥5.50b over a year. However, it also had CN¥3.86b in cash, and so its net debt is CN¥1.31b.

A Look At Tianjin You Fa Steel Pipe Group Stock's Liabilities

The latest balance sheet data shows that Tianjin You Fa Steel Pipe Group Stock had liabilities of CN¥7.51b due within a year, and liabilities of CN¥2.91b falling due after that. Offsetting this, it had CN¥3.86b in cash and CN¥1.37b in receivables that were due within 12 months. So it has liabilities totalling CN¥5.20b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥7.76b, so it does suggest shareholders should keep an eye on Tianjin You Fa Steel Pipe Group Stock's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

Looking at its net debt to EBITDA of 1.1 and interest cover of 5.6 times, it seems to us that Tianjin You Fa Steel Pipe Group Stock 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. Also relevant is that Tianjin You Fa Steel Pipe Group Stock has grown its EBIT by a very respectable 21% in the last year, thus enhancing its ability to pay down 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 Tianjin You Fa Steel Pipe Group Stock'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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Tianjin You Fa Steel Pipe Group Stock burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Tianjin You Fa Steel Pipe Group Stock's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its EBIT growth rate was refreshing. Taking the abovementioned factors together we do think Tianjin You Fa Steel Pipe Group Stock's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. For example - Tianjin You Fa Steel Pipe Group Stock has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.