Yuan Jen EnterprisesLtd (TPE:1725) Could Easily Take On More Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Yuan Jen Enterprises Co.,Ltd. (TPE:1725) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Yuan Jen EnterprisesLtd

What Is Yuan Jen EnterprisesLtd's Net Debt?

As you can see below, at the end of September 2020, Yuan Jen EnterprisesLtd had NT$1.29b of debt, up from NT$1.22b a year ago. Click the image for more detail. But it also has NT$3.02b in cash to offset that, meaning it has NT$1.73b net cash.

How Strong Is Yuan Jen EnterprisesLtd's Balance Sheet?

The latest balance sheet data shows that Yuan Jen EnterprisesLtd had liabilities of NT$1.91b due within a year, and liabilities of NT$79.4m falling due after that. Offsetting this, it had NT$3.02b in cash and NT$828.2m in receivables that were due within 12 months. So it can boast NT$1.86b more liquid assets than total liabilities.

This surplus strongly suggests that Yuan Jen EnterprisesLtd has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Yuan Jen EnterprisesLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Yuan Jen EnterprisesLtd has seen its EBIT plunge 20% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is Yuan Jen EnterprisesLtd'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. While Yuan Jen EnterprisesLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Yuan Jen EnterprisesLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Yuan Jen EnterprisesLtd has net cash of NT$1.73b, as well as more liquid assets than liabilities. The cherry on top was that in converted 164% of that EBIT to free cash flow, bringing in NT$297m. So is Yuan Jen EnterprisesLtd's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 4 warning signs for Yuan Jen EnterprisesLtd (1 is concerning!) 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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