Is China Yongda Automobiles Services Holdings (HKG:3669) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies China Yongda Automobiles Services Holdings Limited (HKG:3669) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for China Yongda Automobiles Services Holdings

How Much Debt Does China Yongda Automobiles Services Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that China Yongda Automobiles Services Holdings had CN¥5.05b of debt in June 2022, down from CN¥6.88b, one year before. On the flip side, it has CN¥3.69b in cash leading to net debt of about CN¥1.36b.

A Look At China Yongda Automobiles Services Holdings' Liabilities

The latest balance sheet data shows that China Yongda Automobiles Services Holdings had liabilities of CN¥12.9b due within a year, and liabilities of CN¥3.84b falling due after that. On the other hand, it had cash of CN¥3.69b and CN¥3.35b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥9.68b.

Given this deficit is actually higher than the company's market capitalization of CN¥7.63b, we think shareholders really should watch China Yongda Automobiles Services Holdings's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

With net debt sitting at just 0.34 times EBITDA, China Yongda Automobiles Services Holdings is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 9.1 times the interest expense over the last year. On the other hand, China Yongda Automobiles Services Holdings saw its EBIT drop by 5.0% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept 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, China Yongda Automobiles Services Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

We feel some trepidation about China Yongda Automobiles Services Holdings'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 net debt to EBITDA were encouraging signs. We think that China Yongda Automobiles Services 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. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for China Yongda Automobiles Services Holdings you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.