Is Yangtze Optical Fibre And Cable Limited (HKG:6869) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Yangtze Optical Fibre And Cable Joint Stock Limited Company (HKG:6869) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

View our latest analysis for Yangtze Optical Fibre And Cable Limited

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

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Yangtze Optical Fibre And Cable Limited had CN¥6.51b of debt, an increase on CN¥3.87b, over one year. However, it also had CN¥5.77b in cash, and so its net debt is CN¥744.0m.

A Look At Yangtze Optical Fibre And Cable Limited's Liabilities

The latest balance sheet data shows that Yangtze Optical Fibre And Cable Limited had liabilities of CN¥8.46b due within a year, and liabilities of CN¥5.42b falling due after that. On the other hand, it had cash of CN¥5.77b and CN¥6.69b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.42b.

Since publicly traded Yangtze Optical Fibre And Cable Limited shares are worth a total of CN¥18.6b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Yangtze Optical Fibre And Cable Limited has a low net debt to EBITDA ratio of only 0.55. And its EBIT covers its interest expense a whopping 2k times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, Yangtze Optical Fibre And Cable Limited grew its EBIT by 290% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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

Happily, Yangtze Optical Fibre And Cable Limited's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. All these things considered, it appears that Yangtze Optical Fibre And Cable Limited can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. We'd be motivated to research the stock further if we found out that Yangtze Optical Fibre And Cable Limited insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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.