We Think Hua Yin International Holdings (HKG:989) Is Taking Some Risk With Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Hua Yin International Holdings Limited (HKG:989) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hua Yin International Holdings

How Much Debt Does Hua Yin International Holdings Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Hua Yin International Holdings had debt of CN¥1.06b, up from CN¥943.9m in one year. On the flip side, it has CN¥74.3m in cash leading to net debt of about CN¥981.1m.

How Strong Is Hua Yin International Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hua Yin International Holdings had liabilities of CN¥1.32b due within 12 months and liabilities of CN¥520.5m due beyond that. Offsetting this, it had CN¥74.3m in cash and CN¥43.5m in receivables that were due within 12 months. So its liabilities total CN¥1.73b more than the combination of its cash and short-term receivables.

Hua Yin International Holdings has a market capitalization of CN¥2.90b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Hua Yin International Holdings's net debt of 1.8 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 7.1 times its interest expenses harmonizes with that theme. Pleasingly, Hua Yin International Holdings is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 231% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hua Yin International Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Considering the last two years, Hua Yin International Holdings actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Hua Yin International Holdings's conversion of EBIT to free cash flow and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. We think that Hua Yin International Holdings'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. 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. Be aware that Hua Yin International Holdings is showing 5 warning signs in our investment analysis , and 2 of those make us uncomfortable...

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.