The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Yongjin Technology Group Co., Ltd. (SHSE:603995) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Yongjin Technology Group
How Much Debt Does Yongjin Technology Group Carry?
The image below, which you can click on for greater detail, shows that at June 2024 Yongjin Technology Group had debt of CN¥3.65b, up from CN¥2.82b in one year. However, it also had CN¥1.77b in cash, and so its net debt is CN¥1.89b.
How Healthy Is Yongjin Technology Group's Balance Sheet?
We can see from the most recent balance sheet that Yongjin Technology Group had liabilities of CN¥5.86b falling due within a year, and liabilities of CN¥2.01b due beyond that. Offsetting these obligations, it had cash of CN¥1.77b as well as receivables valued at CN¥1.02b due within 12 months. So its liabilities total CN¥5.08b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of CN¥6.14b, so it does suggest shareholders should keep an eye on Yongjin Technology Group's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
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.
Yongjin Technology Group's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 11.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Yongjin Technology Group has boosted its EBIT by 59%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Yongjin Technology Group can strengthen its balance sheet over time. 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Yongjin Technology Group 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
We feel some trepidation about Yongjin Technology Group's difficulty conversion of EBIT to free cash flow, but we've got positives to focus on, too. For example, its EBIT growth rate and interest cover give us some confidence in its ability to manage its debt. We think that Yongjin Technology Group'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. 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 instance, we've identified 1 warning sign for Yongjin Technology Group that 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.
About SHSE:603995
Yongjin Technology Group
Engages in the research, development, production, and sale of cold-rolled stainless steel sheets and strips.
Solid track record with excellent balance sheet.