Anxian Yuan China Holdings (HKG:922) Could Easily Take On More 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Anxian Yuan China Holdings Limited (HKG:922) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Anxian Yuan China Holdings

What Is Anxian Yuan China Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Anxian Yuan China Holdings had HK$115.7m of debt in September 2021, down from HK$139.2m, one year before. But on the other hand it also has HK$302.9m in cash, leading to a HK$187.2m net cash position.

A Look At Anxian Yuan China Holdings' Liabilities

According to the last reported balance sheet, Anxian Yuan China Holdings had liabilities of HK$196.8m due within 12 months, and liabilities of HK$229.1m due beyond 12 months. Offsetting this, it had HK$302.9m in cash and HK$2.79m in receivables that were due within 12 months. So its liabilities total HK$120.2m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Anxian Yuan China Holdings has a market capitalization of HK$368.7m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Anxian Yuan China Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Anxian Yuan China Holdings grew its EBIT at 18% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Anxian Yuan China Holdings will need earnings to service that debt. 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 Anxian Yuan China 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. During the last three years, Anxian Yuan China Holdings generated free cash flow amounting to a very robust 97% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While Anxian Yuan China Holdings does have more liabilities than liquid assets, it also has net cash of HK$187.2m. The cherry on top was that in converted 97% of that EBIT to free cash flow, bringing in HK$111m. So we don't think Anxian Yuan China Holdings's use of debt is risky. 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. We've identified 4 warning signs with Anxian Yuan China Holdings , and understanding them should be part of your investment process.

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.