Does Feiyang International Holdings Group (HKG:1901) Have A Healthy Balance Sheet?

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.' 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 note that Feiyang International Holdings Group Limited (HKG:1901) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Our analysis indicates that 1901 is potentially overvalued!

What Is Feiyang International Holdings Group's Net Debt?

As you can see below, Feiyang International Holdings Group had CN¥199.9m of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CN¥65.1m in cash leading to net debt of about CN¥134.8m.

How Strong Is Feiyang International Holdings Group's Balance Sheet?

We can see from the most recent balance sheet that Feiyang International Holdings Group had liabilities of CN¥266.0m falling due within a year, and liabilities of CN¥15.7m due beyond that. Offsetting these obligations, it had cash of CN¥65.1m as well as receivables valued at CN¥73.7m due within 12 months. So it has liabilities totalling CN¥143.0m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Feiyang International Holdings Group has a market capitalization of CN¥640.1m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Weak interest cover of 0.17 times and a disturbingly high net debt to EBITDA ratio of 25.1 hit our confidence in Feiyang International Holdings Group like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, the silver lining was that Feiyang International Holdings Group achieved a positive EBIT of CN¥1.9m in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Feiyang International Holdings Group will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Feiyang International Holdings Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Feiyang International Holdings Group's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least its level of total liabilities is not so bad. Looking at the bigger picture, it seems clear to us that Feiyang International Holdings Group's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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 example Feiyang International Holdings Group has 4 warning signs (and 3 which are concerning) we think you should know about.

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. 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.