We Think Jiyi Holdings (HKG:1495) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Jiyi Holdings Limited (HKG:1495) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Jiyi Holdings

What Is Jiyi Holdings's Debt?

As you can see below, at the end of December 2020, Jiyi Holdings had CN¥233.8m of debt, up from CN¥204.9m a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥22.8m, its net debt is less, at about CN¥211.0m.

How Healthy Is Jiyi Holdings' Balance Sheet?

We can see from the most recent balance sheet that Jiyi Holdings had liabilities of CN¥262.7m falling due within a year, and liabilities of CN¥143.0m due beyond that. Offsetting these obligations, it had cash of CN¥22.8m as well as receivables valued at CN¥841.0m due within 12 months. So it can boast CN¥458.1m more liquid assets than total liabilities.

This luscious liquidity implies that Jiyi Holdings' balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 6.1, it's fair to say Jiyi Holdings does have a significant amount of debt. However, its interest coverage of 2.6 is reasonably strong, which is a good sign. However, one redeeming factor is that Jiyi Holdings grew its EBIT at 14% over the last 12 months, boosting its ability to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Jiyi Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. Over the last three years, Jiyi Holdings 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

We weren't impressed with Jiyi Holdings's net debt to EBITDA, and its conversion of EBIT to free cash flow made us cautious. But its level of total liabilities was significantly redeeming. Considering this range of data points, we think Jiyi Holdings is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Jiyi Holdings (1 is a bit concerning!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. 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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