Yinson Holdings Berhad (KLSE:YINSON) Has A Somewhat Strained Balance Sheet

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Yinson Holdings Berhad (KLSE:YINSON) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Yinson Holdings Berhad

What Is Yinson Holdings Berhad's Debt?

The image below, which you can click on for greater detail, shows that at July 2021 Yinson Holdings Berhad had debt of RM7.33b, up from RM6.01b in one year. However, it also had RM2.05b in cash, and so its net debt is RM5.28b.

How Strong Is Yinson Holdings Berhad's Balance Sheet?

The latest balance sheet data shows that Yinson Holdings Berhad had liabilities of RM3.15b due within a year, and liabilities of RM6.03b falling due after that. Offsetting this, it had RM2.05b in cash and RM645.0m in receivables that were due within 12 months. So it has liabilities totalling RM6.49b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's RM5.85b market capitalization, you might well be inclined to review the balance sheet intently. 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.

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).

Yinson Holdings Berhad has a debt to EBITDA ratio of 3.4 and its EBIT covered its interest expense 4.4 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Looking on the bright side, Yinson Holdings Berhad boosted its EBIT by a silky 87% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Yinson Holdings Berhad 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Yinson Holdings Berhad saw substantial negative free cash flow, in total. 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

We'd go so far as to say Yinson Holdings Berhad's conversion of EBIT to free cash flow was disappointing. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Yinson Holdings Berhad has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. For example, we've discovered 1 warning sign for Yinson Holdings Berhad that you should be aware of before investing here.

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.