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

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Anxian Yuan China Holdings Limited (HKG:922) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Anxian Yuan China Holdings

What Is Anxian Yuan China Holdings's Debt?

As you can see below, Anxian Yuan China Holdings had HK$35.2m of debt at September 2022, down from HK$115.7m a year prior. However, its balance sheet shows it holds HK$241.5m in cash, so it actually has HK$206.3m net cash.

A Look At Anxian Yuan China Holdings' Liabilities

We can see from the most recent balance sheet that Anxian Yuan China Holdings had liabilities of HK$152.7m falling due within a year, and liabilities of HK$166.2m due beyond that. Offsetting these obligations, it had cash of HK$241.5m as well as receivables valued at HK$2.20m due within 12 months. So it has liabilities totalling HK$75.2m more than its cash and near-term receivables, combined.

Anxian Yuan China Holdings has a market capitalization of HK$353.2m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. 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!

In fact Anxian Yuan China Holdings's saving grace is its low debt levels, because its EBIT has tanked 20% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Anxian Yuan China Holdings 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Anxian Yuan China Holdings 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. During the last three years, Anxian Yuan China Holdings produced sturdy free cash flow equating to 79% 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$206.3m. And it impressed us with free cash flow of HK$61m, being 79% of its EBIT. So we are not troubled with Anxian Yuan China Holdings's debt use. 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. To that end, you should be aware of the 2 warning signs we've spotted with Anxian Yuan China Holdings .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.