Yili Chuanning BiotechnologyLtd (SZSE:301301) Could Easily Take On More 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.' 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 Yili Chuanning Biotechnology Co.,Ltd. (SZSE:301301) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Yili Chuanning BiotechnologyLtd

What Is Yili Chuanning BiotechnologyLtd's Debt?

As you can see below, Yili Chuanning BiotechnologyLtd had CN¥2.11b of debt at September 2023, down from CN¥3.25b a year prior. However, because it has a cash reserve of CN¥1.10b, its net debt is less, at about CN¥1.01b.

A Look At Yili Chuanning BiotechnologyLtd's Liabilities

The latest balance sheet data shows that Yili Chuanning BiotechnologyLtd had liabilities of CN¥2.41b due within a year, and liabilities of CN¥967.3m falling due after that. Offsetting this, it had CN¥1.10b in cash and CN¥1.55b in receivables that were due within 12 months. So it has liabilities totalling CN¥727.3m more than its cash and near-term receivables, combined.

Since publicly traded Yili Chuanning BiotechnologyLtd shares are worth a total of CN¥20.4b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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).

Yili Chuanning BiotechnologyLtd has a low net debt to EBITDA ratio of only 0.65. And its EBIT easily covers its interest expense, being 12.0 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, Yili Chuanning BiotechnologyLtd grew its EBIT by 38% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Yili Chuanning BiotechnologyLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Yili Chuanning BiotechnologyLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, Yili Chuanning BiotechnologyLtd's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! We think Yili Chuanning BiotechnologyLtd is no more beholden to its lenders, than the birds are to birdwatchers. For investing nerds like us its balance sheet is almost charming. 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. Case in point: We've spotted 1 warning sign for Yili Chuanning BiotechnologyLtd you should be aware of.

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.