Yangzijiang Shipbuilding (Holdings) (SGX:BS6) Seems To Use Debt Rather Sparingly

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, Yangzijiang Shipbuilding (Holdings) Ltd. (SGX:BS6) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Yangzijiang Shipbuilding (Holdings)

What Is Yangzijiang Shipbuilding (Holdings)'s Debt?

The chart below, which you can click on for greater detail, shows that Yangzijiang Shipbuilding (Holdings) had CN¥4.57b in debt in December 2022; about the same as the year before. However, its balance sheet shows it holds CN¥12.5b in cash, so it actually has CN¥7.91b net cash.

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¥12.3b falling due within a year, and liabilities of CN¥3.01b due beyond that. Offsetting this, it had CN¥12.5b in cash and CN¥7.14b in receivables that were due within 12 months. So it can boast CN¥4.35b more liquid assets than total liabilities.

It's good to see that Yangzijiang Shipbuilding (Holdings) has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Yangzijiang Shipbuilding (Holdings) has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Yangzijiang Shipbuilding (Holdings) grew its EBIT by 60% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Yangzijiang Shipbuilding (Holdings)'s ability to maintain a healthy balance sheet going forward. 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. 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. Happily for any shareholders, Yangzijiang Shipbuilding (Holdings) actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Yangzijiang Shipbuilding (Holdings) has CN¥7.91b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥3.7b, being 105% of its EBIT. When it comes to Yangzijiang Shipbuilding (Holdings)'s debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. 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.