Anxian Yuan China Holdings (HKG:922) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Anxian Yuan China Holdings Limited (HKG:922) makes use of debt. 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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Anxian Yuan China Holdings

How Much Debt Does Anxian Yuan China Holdings Carry?

The image below, which you can click on for greater detail, shows that Anxian Yuan China Holdings had debt of HK$139.2m at the end of September 2020, a reduction from HK$191.1m over a year. However, its balance sheet shows it holds HK$235.8m in cash, so it actually has HK$96.6m net cash.

How Strong Is Anxian Yuan China Holdings' Balance Sheet?

According to the last reported balance sheet, Anxian Yuan China Holdings had liabilities of HK$147.0m due within 12 months, and liabilities of HK$245.4m due beyond 12 months. On the other hand, it had cash of HK$235.8m and HK$1.01m worth of receivables due within a year. So it has liabilities totalling HK$155.6m more than its cash and near-term receivables, combined.

Anxian Yuan China Holdings has a market capitalization of HK$320.9m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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!

Even more impressive was the fact that Anxian Yuan China Holdings grew its EBIT by 225% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is Anxian Yuan China Holdings's earnings that will influence how the balance sheet holds up in the future. 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. 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 produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

Although Anxian Yuan China Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$96.6m. And we liked the look of last year's 225% year-on-year EBIT growth. 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. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Anxian Yuan China Holdings (at least 1 which is concerning) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. 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.
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