These 4 Measures Indicate That YLI Holdings Berhad (KLSE:YLI) Is Using Debt Extensively

Warren Buffett famously said, '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. As with many other companies YLI Holdings Berhad (KLSE:YLI) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for YLI Holdings Berhad

What Is YLI Holdings Berhad's Debt?

The chart below, which you can click on for greater detail, shows that YLI Holdings Berhad had RM46.4m in debt in March 2021; about the same as the year before. However, it does have RM9.81m in cash offsetting this, leading to net debt of about RM36.6m.

A Look At YLI Holdings Berhad's Liabilities

The latest balance sheet data shows that YLI Holdings Berhad had liabilities of RM83.6m due within a year, and liabilities of RM1.24m falling due after that. Offsetting this, it had RM9.81m in cash and RM49.6m in receivables that were due within 12 months. So its liabilities total RM25.5m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of RM40.1m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). 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).

YLI Holdings Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (7.3), and fairly weak interest coverage, since EBIT is just 0.57 times the interest expense. This means we'd consider it to have a heavy debt load. One redeeming factor for YLI Holdings Berhad is that it turned last year's EBIT loss into a gain of RM1.4m, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is YLI Holdings Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, YLI Holdings Berhad generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Neither YLI Holdings Berhad's ability to cover its interest expense with its EBIT nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that YLI Holdings Berhad is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that YLI Holdings Berhad is showing 2 warning signs in our investment analysis , you should know about...

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. 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.
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