Health Check: How Prudently Does Wai Yuen Tong Medicine Holdings (HKG:897) Use Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Wai Yuen Tong Medicine Holdings Limited (HKG:897) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Wai Yuen Tong Medicine Holdings

How Much Debt Does Wai Yuen Tong Medicine Holdings Carry?

As you can see below, at the end of September 2020, Wai Yuen Tong Medicine Holdings had HK$1.80b of debt, up from HK$921.6m a year ago. Click the image for more detail. However, it also had HK$638.1m in cash, and so its net debt is HK$1.17b.

How Strong Is Wai Yuen Tong Medicine Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Wai Yuen Tong Medicine Holdings had liabilities of HK$2.80b due within 12 months and liabilities of HK$1.83b due beyond that. Offsetting these obligations, it had cash of HK$638.1m as well as receivables valued at HK$275.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$3.71b.

The deficiency here weighs heavily on the HK$455.7m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Wai Yuen Tong Medicine Holdings would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is Wai Yuen Tong Medicine 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.

Over 12 months, Wai Yuen Tong Medicine Holdings reported revenue of HK$849m, which is a gain of 23%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Despite the top line growth, Wai Yuen Tong Medicine Holdings still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable HK$84m at the EBIT level. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it lost HK$170m in the last year. So we think buying this stock is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Wai Yuen Tong Medicine Holdings is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

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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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.
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