China Yongda Automobiles Services Holdings (HKG:3669) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 China Yongda Automobiles Services Holdings Limited (HKG:3669) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for China Yongda Automobiles Services Holdings

What Is China Yongda Automobiles Services Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that China Yongda Automobiles Services Holdings had CN¥6.88b of debt in June 2021, down from CN¥11.7b, one year before. However, it also had CN¥4.13b in cash, and so its net debt is CN¥2.74b.

A Look At China Yongda Automobiles Services Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that China Yongda Automobiles Services Holdings had liabilities of CN¥16.0b due within 12 months and liabilities of CN¥3.65b due beyond that. On the other hand, it had cash of CN¥4.13b and CN¥3.86b worth of receivables due within a year. So its liabilities total CN¥11.7b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥18.7b, so it does suggest shareholders should keep an eye on China Yongda Automobiles Services Holdings' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While China Yongda Automobiles Services Holdings's low debt to EBITDA ratio of 0.64 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.7 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. In addition to that, we're happy to report that China Yongda Automobiles Services Holdings has boosted its EBIT by 47%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if China Yongda Automobiles Services Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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, China Yongda Automobiles Services Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

The good news is that China Yongda Automobiles Services Holdings's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. Taking all this data into account, it seems to us that China Yongda Automobiles Services Holdings takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. For example - China Yongda Automobiles Services Holdings has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.