Would Hua Yin International Holdings (HKG:989) Be Better Off With Less Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Hua Yin International Holdings Limited (HKG:989) 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 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hua Yin International Holdings

What Is Hua Yin International Holdings's Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Hua Yin International Holdings had debt of CN¥1.03b, up from CN¥945.6m in one year. On the flip side, it has CN¥93.2m in cash leading to net debt of about CN¥932.5m.

How Healthy Is Hua Yin International Holdings' Balance Sheet?

The latest balance sheet data shows that Hua Yin International Holdings had liabilities of CN¥1.58b due within a year, and liabilities of CN¥450.7m falling due after that. Offsetting this, it had CN¥93.2m in cash and CN¥55.7m in receivables that were due within 12 months. So it has liabilities totalling CN¥1.88b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Hua Yin International Holdings is worth CN¥3.16b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hua Yin International Holdings's earnings that will influence how the balance sheet holds up in the future. 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.

Over 12 months, Hua Yin International Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥112m, which is a fall of 27%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Hua Yin International Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥4.0m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥97m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. 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. We've identified 3 warning signs with Hua Yin International Holdings (at least 2 which are a bit concerning) , and understanding them should be part of your investment process.

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. 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.