These 4 Measures Indicate That Yip's Chemical Holdings (HKG:408) Is Using Debt Safely

Warren Buffett famously said, '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. As with many other companies Yip's Chemical Holdings Limited (HKG:408) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Yip's Chemical Holdings

How Much Debt Does Yip's Chemical Holdings Carry?

As you can see below, Yip's Chemical Holdings had HK$1.63b of debt at December 2020, down from HK$1.98b a year prior. However, because it has a cash reserve of HK$565.3m, its net debt is less, at about HK$1.07b.

How Healthy Is Yip's Chemical Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Yip's Chemical Holdings had liabilities of HK$3.20b due within 12 months and liabilities of HK$1.02b due beyond that. Offsetting this, it had HK$565.3m in cash and HK$3.97b in receivables that were due within 12 months. So it can boast HK$318.9m more liquid assets than total liabilities.

This surplus suggests that Yip's Chemical Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Yip's Chemical Holdings's net debt is only 1.3 times its EBITDA. And its EBIT easily covers its interest expense, being 19.4 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Yip's Chemical Holdings grew its EBIT by 38% 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 it is Yip's Chemical Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Yip's Chemical Holdings recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Yip's Chemical Holdings's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Considering this range of factors, it seems to us that Yip's Chemical Holdings is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Yip's Chemical 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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