Yue Yuen Industrial (Holdings) (HKG:551) Is Making Moderate Use Of Debt

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Yue Yuen Industrial (Holdings) Limited (HKG:551) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out 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$1.89b at the end of December 2020, a reduction from US$2.10b over a year. However, it also had US$1.02b in cash, and so its net debt is US$878.1m.

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

We can see from the most recent balance sheet that Yue Yuen Industrial (Holdings) had liabilities of US$2.34b falling due within a year, and liabilities of US$1.81b due beyond that. On the other hand, it had cash of US$1.02b and US$1.41b worth of receivables due within a year. So it has liabilities totalling US$1.72b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Yue Yuen Industrial (Holdings) is worth US$4.15b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. 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're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Yue Yuen Industrial (Holdings) had a loss before interest and tax, and actually shrunk its revenue by 16%, to US$8.4b. That's not what we would hope to see.

Caveat Emptor

Not only did Yue Yuen Industrial (Holdings)'s revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at US$10m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of US$91m into a profit. So in short it's a really risky stock. 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. We've identified 1 warning sign with Yue Yuen Industrial (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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