Does Yadea Group Holdings (HKG:1585) Have A Healthy Balance Sheet?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Yadea Group Holdings Ltd. (HKG:1585) makes use of debt. But should shareholders be worried about its use of debt?

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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

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How Much Debt Does Yadea Group Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Yadea Group Holdings had CN¥2.14b of debt, an increase on CN¥253.8m, over one year. However, it does have CN¥10.5b in cash offsetting this, leading to net cash of CN¥8.36b.

How Strong Is Yadea Group Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Yadea Group Holdings had liabilities of CN¥16.1b due within 12 months and liabilities of CN¥622.8m due beyond that. Offsetting these obligations, it had cash of CN¥10.5b as well as receivables valued at CN¥443.8m due within 12 months. So its liabilities total CN¥5.81b more than the combination of its cash and short-term receivables.

Given Yadea Group Holdings has a market capitalization of CN¥36.4b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Yadea Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Yadea Group Holdings grew its EBIT by 43% 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 Yadea Group Holdings 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. Yadea Group Holdings 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. Over the last three years, Yadea Group Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although Yadea Group Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥8.36b. And it impressed us with free cash flow of CN¥641m, being 174% of its EBIT. So is Yadea Group Holdings's debt a risk? It doesn't seem so to us. 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. We've identified 1 warning sign with Yadea Group Holdings , and understanding them should be part of your investment process.

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.