Is Beijing Oriental Yuhong Waterproof Technology (SZSE:002271) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. We can see that Beijing Oriental Yuhong Waterproof Technology Co., Ltd. (SZSE:002271) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Beijing Oriental Yuhong Waterproof Technology

What Is Beijing Oriental Yuhong Waterproof Technology's Debt?

As you can see below, Beijing Oriental Yuhong Waterproof Technology had CN¥6.87b of debt at September 2023, down from CN¥7.73b a year prior. However, it does have CN¥4.80b in cash offsetting this, leading to net debt of about CN¥2.07b.

How Strong Is Beijing Oriental Yuhong Waterproof Technology's Balance Sheet?

We can see from the most recent balance sheet that Beijing Oriental Yuhong Waterproof Technology had liabilities of CN¥18.3b falling due within a year, and liabilities of CN¥2.05b due beyond that. Offsetting these obligations, it had cash of CN¥4.80b as well as receivables valued at CN¥22.3b due within 12 months. So it can boast CN¥6.67b more liquid assets than total liabilities.

It's good to see that Beijing Oriental Yuhong Waterproof Technology has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders.

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). 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).

Beijing Oriental Yuhong Waterproof Technology's net debt is only 0.41 times its EBITDA. And its EBIT covers its interest expense a whopping 68.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also good is that Beijing Oriental Yuhong Waterproof Technology grew its EBIT at 13% over the last year, further increasing its ability to manage 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 Beijing Oriental Yuhong Waterproof 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, 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. Over the last three years, Beijing Oriental Yuhong Waterproof Technology saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Happily, Beijing Oriental Yuhong Waterproof Technology's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Beijing Oriental Yuhong Waterproof Technology can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Beijing Oriental Yuhong Waterproof Technology's earnings per share history for free.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.