Yunnan Baiyao GroupLtd (SZSE:000538) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Yunnan Baiyao Group Co.,Ltd (SZSE:000538) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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 Yunnan Baiyao GroupLtd

How Much Debt Does Yunnan Baiyao GroupLtd Carry?

As you can see below, Yunnan Baiyao GroupLtd had CN¥1.72b of debt at March 2024, down from CN¥1.86b a year prior. But on the other hand it also has CN¥17.2b in cash, leading to a CN¥15.4b net cash position.

A Look At Yunnan Baiyao GroupLtd's Liabilities

The latest balance sheet data shows that Yunnan Baiyao GroupLtd had liabilities of CN¥14.1b due within a year, and liabilities of CN¥1.14b falling due after that. Offsetting this, it had CN¥17.2b in cash and CN¥13.8b in receivables that were due within 12 months. So it actually has CN¥15.7b more liquid assets than total liabilities.

It's good to see that Yunnan Baiyao GroupLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Yunnan Baiyao GroupLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Yunnan Baiyao GroupLtd has increased its EBIT by 4.2% over twelve months, which should ease any concerns about debt repayment. 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 Yunnan Baiyao GroupLtd'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 company can only pay off debt with cold hard cash, not accounting profits. Yunnan Baiyao GroupLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Yunnan Baiyao GroupLtd generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Yunnan Baiyao GroupLtd has net cash of CN¥15.4b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.8b, being 96% of its EBIT. So we don't think Yunnan Baiyao GroupLtd's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Yunnan Baiyao GroupLtd you should know about.

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.

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