Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 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.
What Risk Does Debt Bring?
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. 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.
What Is Anxian Yuan China Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that Anxian Yuan China Holdings had debt of HK$129.4m at the end of March 2021, a reduction from HK$163.5m over a year. But on the other hand it also has HK$256.6m in cash, leading to a HK$127.2m net cash position.
How Healthy Is Anxian Yuan China Holdings' Balance Sheet?
The latest balance sheet data shows that Anxian Yuan China Holdings had liabilities of HK$165.3m due within a year, and liabilities of HK$240.1m falling due after that. On the other hand, it had cash of HK$256.6m and HK$2.94m worth of receivables due within a year. So it has liabilities totalling HK$145.8m more than its cash and near-term receivables, combined.
This deficit isn't so bad because Anxian Yuan China Holdings is worth HK$457.6m, and thus could probably raise enough capital to shore up 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!
On top of that, Anxian Yuan China Holdings grew its EBIT by 41% over the last twelve months, and that growth will make it easier to handle its 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 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. Over the last three years, Anxian Yuan China Holdings recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While Anxian Yuan China Holdings does have more liabilities than liquid assets, it also has net cash of HK$127.2m. And it impressed us with free cash flow of HK$102m, being 87% of its EBIT. So we don't think Anxian Yuan China Holdings's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Anxian Yuan China Holdings (1 is concerning) you should be aware of.
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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