Here's Why Yangtze Optical Fibre And Cable Limited (HKG:6869) Has A Meaningful Debt Burden

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.' 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. We can see that Yangtze Optical Fibre And Cable Joint Stock Limited Company (HKG:6869) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Yangtze Optical Fibre And Cable Limited

What Is Yangtze Optical Fibre And Cable Limited's Net Debt?

As you can see below, at the end of September 2021, Yangtze Optical Fibre And Cable Limited had CN¥3.87b of debt, up from CN¥2.29b a year ago. Click the image for more detail. On the flip side, it has CN¥3.71b in cash leading to net debt of about CN¥152.3m.

How Strong Is Yangtze Optical Fibre And Cable Limited's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Yangtze Optical Fibre And Cable Limited had liabilities of CN¥5.60b due within 12 months and liabilities of CN¥3.11b due beyond that. Offsetting this, it had CN¥3.71b in cash and CN¥5.31b in receivables that were due within 12 months. So it actually has CN¥315.2m more liquid assets than total liabilities.

Having regard to Yangtze Optical Fibre And Cable Limited's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥17.9b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, Yangtze Optical Fibre And Cable Limited has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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.

Yangtze Optical Fibre And Cable Limited has a low debt to EBITDA ratio of only 0.23. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. In fact Yangtze Optical Fibre And Cable Limited's saving grace is its low debt levels, because its EBIT has tanked 45% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Yangtze Optical Fibre And Cable Limited can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. During the last three years, Yangtze Optical Fibre And Cable Limited burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

While Yangtze Optical Fibre And Cable Limited's EBIT growth rate has us nervous. To wit both its interest cover and net debt to EBITDA were encouraging signs. Looking at all the angles mentioned above, it does seem to us that Yangtze Optical Fibre And Cable Limited is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Yangtze Optical Fibre And Cable Limited you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.