Is Yangzijiang Shipbuilding (Holdings) (SGX:BS6) 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.' 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. As with many other companies Yangzijiang Shipbuilding (Holdings) Ltd. (SGX:BS6) makes use of debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Our analysis indicates that BS6 is potentially undervalued!

What Is Yangzijiang Shipbuilding (Holdings)'s Net Debt?

As you can see below, at the end of June 2022, Yangzijiang Shipbuilding (Holdings) had CN¥5.33b of debt, up from CN¥4.68b a year ago. Click the image for more detail. However, it does have CN¥11.4b in cash offsetting this, leading to net cash of CN¥6.07b.

How Healthy Is Yangzijiang Shipbuilding (Holdings)'s Balance Sheet?

We can see from the most recent balance sheet that Yangzijiang Shipbuilding (Holdings) had liabilities of CN¥12.6b falling due within a year, and liabilities of CN¥2.32b due beyond that. On the other hand, it had cash of CN¥11.4b and CN¥8.48b worth of receivables due within a year. So it can boast CN¥4.98b more liquid assets than total liabilities.

This surplus suggests that Yangzijiang Shipbuilding (Holdings) is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Yangzijiang Shipbuilding (Holdings) boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Yangzijiang Shipbuilding (Holdings) has boosted its EBIT by 43%, thus reducing the spectre of future debt repayments. 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 Yangzijiang Shipbuilding (Holdings) 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. Yangzijiang Shipbuilding (Holdings) may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Yangzijiang Shipbuilding (Holdings) actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Yangzijiang Shipbuilding (Holdings) has net cash of CN¥6.07b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥3.4b, being 126% of its EBIT. The bottom line is that we do not find Yangzijiang Shipbuilding (Holdings)'s debt levels at all concerning. 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. We've identified 1 warning sign with Yangzijiang Shipbuilding (Holdings) , and understanding them should be part of your investment process.

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.