We Think YONFER Agricultural Technology (SZSE:000902) Is Taking Some Risk With 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, YONFER Agricultural Technology Co., Ltd. (SZSE:000902) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for YONFER Agricultural Technology

What Is YONFER Agricultural Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 YONFER Agricultural Technology had CN¥1.77b of debt, an increase on CN¥1.28b, over one year. On the flip side, it has CN¥1.52b in cash leading to net debt of about CN¥248.7m.

How Healthy Is YONFER Agricultural Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that YONFER Agricultural Technology had liabilities of CN¥4.34b due within 12 months and liabilities of CN¥2.14b due beyond that. On the other hand, it had cash of CN¥1.52b and CN¥558.7m worth of receivables due within a year. So its liabilities total CN¥4.41b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since YONFER Agricultural Technology has a market capitalization of CN¥15.1b, 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

YONFER Agricultural Technology's net debt is only 0.13 times its EBITDA. And its EBIT easily covers its interest expense, being 105 times the size. So we're pretty relaxed about its super-conservative use of debt. On the other hand, YONFER Agricultural Technology's EBIT dived 16%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine YONFER Agricultural Technology'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, YONFER Agricultural Technology burned a lot of cash. 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

We feel some trepidation about YONFER Agricultural Technology's difficulty conversion of EBIT to free cash flow, but we've got positives to focus on, too. For example, its interest cover and net debt to EBITDA give us some confidence in its ability to manage its debt. When we consider all the factors discussed, it seems to us that YONFER Agricultural Technology is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with YONFER Agricultural Technology , 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.

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