Would Yanchang Petroleum International (HKG:346) Be Better Off With Less 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.' 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 Yanchang Petroleum International Limited (HKG:346) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Yanchang Petroleum International

How Much Debt Does Yanchang Petroleum International Carry?

As you can see below, Yanchang Petroleum International had HK$843.5m of debt at December 2020, down from HK$996.2m a year prior. However, it does have HK$436.1m in cash offsetting this, leading to net debt of about HK$407.4m.

How Strong Is Yanchang Petroleum International's Balance Sheet?

We can see from the most recent balance sheet that Yanchang Petroleum International had liabilities of HK$1.32b falling due within a year, and liabilities of HK$510.1m due beyond that. On the other hand, it had cash of HK$436.1m and HK$353.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$1.05b.

This is a mountain of leverage relative to its market capitalization of HK$1.56b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Yanchang Petroleum International 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.

In the last year Yanchang Petroleum International wasn't profitable at an EBIT level, but managed to grow its revenue by 231%, to HK$27b. That's virtually the hole-in-one of revenue growth!

Caveat Emptor

Even though Yanchang Petroleum International managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. To be specific the EBIT loss came in at HK$30m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled HK$118m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very 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. To that end, you should learn about the 3 warning signs we've spotted with Yanchang Petroleum International (including 2 which can't be ignored) .

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.

If you’re looking to trade a wide range of investments, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.