Is Yankuang Energy Group (HKG:1171) A Risky Investment?

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. As with many other companies Yankuang Energy Group Company Limited (HKG:1171) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Yankuang Energy Group

What Is Yankuang Energy Group's Debt?

The image below, which you can click on for greater detail, shows that Yankuang Energy Group had debt of CN¥76.2b at the end of March 2023, a reduction from CN¥95.5b over a year. However, it does have CN¥52.6b in cash offsetting this, leading to net debt of about CN¥23.6b.

How Strong Is Yankuang Energy Group's Balance Sheet?

According to the last reported balance sheet, Yankuang Energy Group had liabilities of CN¥84.5b due within 12 months, and liabilities of CN¥82.5b due beyond 12 months. Offsetting these obligations, it had cash of CN¥52.6b as well as receivables valued at CN¥15.2b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥99.2b.

This deficit is considerable relative to its very significant market capitalization of CN¥117.7b, so it does suggest shareholders should keep an eye on Yankuang Energy Group's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Yankuang Energy Group has a low net debt to EBITDA ratio of only 0.34. And its EBIT easily covers its interest expense, being 20.6 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, Yankuang Energy Group grew its EBIT by 59% over the last twelve months, and that growth will make it easier to handle its debt. 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 Yankuang Energy Group 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Yankuang Energy Group produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Yankuang Energy Group's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. Taking all this data into account, it seems to us that Yankuang Energy Group takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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 2 warning signs for Yankuang Energy Group (1 is concerning) you should be aware of.

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. 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.