Is Yincheng International Holding (HKG:1902) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Yincheng International Holding Co., Ltd. (HKG:1902) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Yincheng International Holding

What Is Yincheng International Holding's Debt?

As you can see below, at the end of December 2020, Yincheng International Holding had CN¥14.4b of debt, up from CN¥10.5b a year ago. Click the image for more detail. However, it does have CN¥5.45b in cash offsetting this, leading to net debt of about CN¥8.91b.

How Strong Is Yincheng International Holding's Balance Sheet?

According to the last reported balance sheet, Yincheng International Holding had liabilities of CN¥30.4b due within 12 months, and liabilities of CN¥8.97b due beyond 12 months. Offsetting these obligations, it had cash of CN¥5.45b as well as receivables valued at CN¥4.82b due within 12 months. So it has liabilities totalling CN¥29.1b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥3.75b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Yincheng International Holding would probably need a major re-capitalization if its creditors were to demand repayment.

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.

Yincheng International Holding has a rather high debt to EBITDA ratio of 13.2 which suggests a meaningful debt load. However, its interest coverage of 4.5 is reasonably strong, which is a good sign. Shareholders should be aware that Yincheng International Holding's EBIT was down 25% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Yincheng International Holding 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Yincheng International Holding saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Yincheng International Holding's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its interest cover is not so bad. It looks to us like Yincheng International Holding carries a significant balance sheet burden. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Yincheng International Holding (of which 1 can't be ignored!) you should know about.

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.

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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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