We Think China YuHua Education (HKG:6169) 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.' 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 note that China YuHua Education Corporation Limited (HKG:6169) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for China YuHua Education

How Much Debt Does China YuHua Education Carry?

You can click the graphic below for the historical numbers, but it shows that China YuHua Education had CN¥1.35b of debt in February 2023, down from CN¥2.31b, one year before. However, its balance sheet shows it holds CN¥2.93b in cash, so it actually has CN¥1.58b net cash.

How Healthy Is China YuHua Education's Balance Sheet?

We can see from the most recent balance sheet that China YuHua Education had liabilities of CN¥2.48b falling due within a year, and liabilities of CN¥1.81b due beyond that. Offsetting these obligations, it had cash of CN¥2.93b as well as receivables valued at CN¥66.1m due within 12 months. So its liabilities total CN¥1.28b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because China YuHua Education is worth CN¥2.88b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, China YuHua Education boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that China YuHua Education's load is not too heavy, because its EBIT was down 33% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if China YuHua Education can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. China YuHua Education may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, China YuHua Education actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While China YuHua Education does have more liabilities than liquid assets, it also has net cash of CN¥1.58b. The cherry on top was that in converted 107% of that EBIT to free cash flow, bringing in CN¥666m. So we are not troubled with China YuHua Education's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for China YuHua Education that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.