These 4 Measures Indicate That Yincheng International Holding (HKG:1902) Is Using Debt Extensively

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.' 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. Importantly, Yincheng International Holding Co., Ltd. (HKG:1902) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Yincheng International Holding

What Is Yincheng International Holding's Net Debt?

As you can see below, Yincheng International Holding had CN¥11.7b of debt at June 2022, down from CN¥15.7b a year prior. However, because it has a cash reserve of CN¥2.37b, its net debt is less, at about CN¥9.33b.

A Look At Yincheng International Holding's Liabilities

Zooming in on the latest balance sheet data, we can see that Yincheng International Holding had liabilities of CN¥28.8b due within 12 months and liabilities of CN¥6.77b due beyond that. Offsetting these obligations, it had cash of CN¥2.37b as well as receivables valued at CN¥6.91b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥26.3b.

This deficit casts a shadow over the CN¥2.27b 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.

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). 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 5.7 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 6.1 times, suggesting it can responsibly service its obligations. Pleasingly, Yincheng International Holding is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 151% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Yincheng International Holding'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Yincheng International Holding actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

We feel some trepidation about Yincheng International Holding's difficulty level of total liabilities, but we've got positives to focus on, too. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. We think that Yincheng International Holding's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Yincheng International Holding you should be aware of, and 2 of them are potentially serious.

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.

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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.