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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Yangtze Optical Fibre And Cable Joint Stock Limited Company (HKG:6869) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Yangtze Optical Fibre And Cable Limited

How Much Debt Does Yangtze Optical Fibre And Cable Limited Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Yangtze Optical Fibre And Cable Limited had CN¥7.26b of debt, an increase on CN¥5.31b, over one year. On the flip side, it has CN¥5.62b in cash leading to net debt of about CN¥1.65b.

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¥7.52b due within 12 months and liabilities of CN¥6.63b due beyond that. Offsetting these obligations, it had cash of CN¥5.62b as well as receivables valued at CN¥6.06b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.47b.

Since publicly traded Yangtze Optical Fibre And Cable Limited shares are worth a total of CN¥18.9b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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 net debt to EBITDA ratio of only 0.97. And its EBIT easily covers its interest expense, being 35.6 times the size. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Yangtze Optical Fibre And Cable Limited grew its EBIT by 123% over twelve months. That boost will make it even easier to pay down debt going forward. 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 we always check how much of that EBIT is translated into free cash flow. During the last three years, Yangtze Optical Fibre And Cable Limited burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far 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. Looking at all the aforementioned factors together, it strikes us that Yangtze Optical Fibre And Cable Limited can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Yangtze Optical Fibre And Cable Limited you should know about.

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.