These 4 Measures Indicate That Yue Yuen Industrial (Holdings) (HKG:551) Is Using Debt Safely

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Yue Yuen Industrial (Holdings) Limited (HKG:551) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Yue Yuen Industrial (Holdings)

What Is Yue Yuen Industrial (Holdings)'s Net Debt?

The image below, which you can click on for greater detail, shows that Yue Yuen Industrial (Holdings) had debt of US$857.0m at the end of June 2024, a reduction from US$1.20b over a year. However, it does have US$741.6m in cash offsetting this, leading to net debt of about US$115.3m.

A Look At Yue Yuen Industrial (Holdings)'s Liabilities

Zooming in on the latest balance sheet data, we can see that Yue Yuen Industrial (Holdings) had liabilities of US$1.66b due within 12 months and liabilities of US$814.4m due beyond that. Offsetting this, it had US$741.6m in cash and US$1.55b in receivables that were due within 12 months. So it has liabilities totalling US$179.4m more than its cash and near-term receivables, combined.

Of course, Yue Yuen Industrial (Holdings) has a market capitalization of US$2.89b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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).

With net debt sitting at just 0.19 times EBITDA, Yue Yuen Industrial (Holdings) is arguably pretty conservatively geared. And it boasts interest cover of 9.0 times, which is more than adequate. In addition to that, we're happy to report that Yue Yuen Industrial (Holdings) has boosted its EBIT by 31%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Yue Yuen Industrial (Holdings)'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Yue Yuen Industrial (Holdings) actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that Yue Yuen Industrial (Holdings)'s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. It looks Yue Yuen Industrial (Holdings) has no trouble standing on its own two feet, and it has no reason to fear its lenders. To our minds it has a healthy happy balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Yue Yuen Industrial (Holdings) that 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.