We Think Yuk Wing Group Holdings (HKG:1536) Can Stay On Top Of Its 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.' 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. We can see that Yuk Wing Group Holdings Limited (HKG:1536) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Yuk Wing Group Holdings

What Is Yuk Wing Group Holdings's Net Debt?

As you can see below, Yuk Wing Group Holdings had HK$20.0m of debt at September 2020, down from HK$26.4m a year prior. However, its balance sheet shows it holds HK$95.3m in cash, so it actually has HK$75.3m net cash.

A Look At Yuk Wing Group Holdings' Liabilities

According to the last reported balance sheet, Yuk Wing Group Holdings had liabilities of HK$43.2m due within 12 months, and liabilities of HK$13.9m due beyond 12 months. Offsetting this, it had HK$95.3m in cash and HK$50.6m in receivables that were due within 12 months. So it actually has HK$88.7m more liquid assets than total liabilities.

This surplus liquidity suggests that Yuk Wing Group Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Yuk Wing Group Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Yuk Wing Group Holdings's saving grace is its low debt levels, because its EBIT has tanked 76% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is Yuk Wing Group Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Yuk Wing Group Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Considering the last three years, Yuk Wing Group Holdings actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While it is always sensible to investigate a company's debt, in this case Yuk Wing Group Holdings has HK$75.3m in net cash and a decent-looking balance sheet. So we don't have any problem with Yuk Wing Group Holdings's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Yuk Wing Group Holdings has 3 warning signs we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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