We Think Yulon Nissan Motor (TPE:2227) Is Taking Some Risk With Its Debt

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.' 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. Importantly, Yulon Nissan Motor Co., Ltd (TPE:2227) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Yulon Nissan Motor

How Much Debt Does Yulon Nissan Motor Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Yulon Nissan Motor had debt of NT$2.16b, up from none in one year. However, it does have NT$8.42b in cash offsetting this, leading to net cash of NT$6.26b.

How Healthy Is Yulon Nissan Motor's Balance Sheet?

The latest balance sheet data shows that Yulon Nissan Motor had liabilities of NT$4.67b due within a year, and liabilities of NT$4.49b falling due after that. Offsetting this, it had NT$8.42b in cash and NT$2.91b in receivables that were due within 12 months. So it can boast NT$2.17b more liquid assets than total liabilities.

This short term liquidity is a sign that Yulon Nissan Motor could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Yulon Nissan Motor boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Yulon Nissan Motor if management cannot prevent a repeat of the 36% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Yulon Nissan Motor's ability to maintain a healthy balance sheet going forward. 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. Yulon Nissan Motor 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. During the last three years, Yulon Nissan Motor burned a lot of cash. 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.

Summing up

While it is always sensible to investigate a company's debt, in this case Yulon Nissan Motor has NT$6.26b in net cash and a decent-looking balance sheet. So while Yulon Nissan Motor does not have a great balance sheet, it's certainly not too bad. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Yulon Nissan Motor (at least 1 which can't be ignored) , 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. 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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