Here's Why Yunnan Energy International (HKG:1298) Can Afford Some Debt

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.' 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 Yunnan Energy International Co. Limited (HKG:1298) makes use of debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Yunnan Energy International

What Is Yunnan Energy International's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Yunnan Energy International had HK$160.7m of debt, an increase on HK$71.1m, over one year. However, because it has a cash reserve of HK$91.3m, its net debt is less, at about HK$69.5m.

A Look At Yunnan Energy International's Liabilities

According to the balance sheet data, Yunnan Energy International had liabilities of HK$203.8m due within 12 months, but no longer term liabilities. Offsetting these obligations, it had cash of HK$91.3m as well as receivables valued at HK$125.2m due within 12 months. So it can boast HK$12.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Yunnan Energy International could probably pay off its debt with ease, as its balance sheet is far from stretched. 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 Yunnan Energy International 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.

Over 12 months, Yunnan Energy International reported revenue of HK$282m, which is a gain of 59%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

While we can certainly appreciate Yunnan Energy International's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at HK$5.8m. On a more positive note, the company does have liquid assets, so it has a bit of time to improve its operations before the debt becomes an acute problem. Still, we'd be more encouraged to study the business in depth if it already had some free cash flow. This one is a bit too risky for our liking. 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. For example Yunnan Energy International has 4 warning signs (and 3 which are significant) we think you should know about.

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.

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

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.