These 4 Measures Indicate That Yi Jinn Industrial (TPE:1457) Is Using Debt Extensively

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.' 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 Yi Jinn Industrial Co., Ltd. (TPE:1457) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Yi Jinn Industrial

What Is Yi Jinn Industrial's Debt?

The image below, which you can click on for greater detail, shows that Yi Jinn Industrial had debt of NT$8.20b at the end of September 2020, a reduction from NT$8.88b over a year. On the flip side, it has NT$912.7m in cash leading to net debt of about NT$7.28b.

How Healthy Is Yi Jinn Industrial's Balance Sheet?

The latest balance sheet data shows that Yi Jinn Industrial had liabilities of NT$1.75b due within a year, and liabilities of NT$7.23b falling due after that. Offsetting these obligations, it had cash of NT$912.7m as well as receivables valued at NT$459.1m due within 12 months. So its liabilities total NT$7.60b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the NT$3.31b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Yi Jinn Industrial would probably need a major re-capitalization if its creditors were to demand repayment.

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).

With a net debt to EBITDA ratio of 11.9, it's fair to say Yi Jinn Industrial does have a significant amount of debt. However, its interest coverage of 4.1 is reasonably strong, which is a good sign. The good news is that Yi Jinn Industrial grew its EBIT a smooth 35% over the last twelve months. 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 you can't view debt in total isolation; since Yi Jinn Industrial will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Yi Jinn Industrial 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.

Our View

On the face of it, Yi Jinn Industrial's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Overall, it seems to us that Yi Jinn Industrial's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Yi Jinn Industrial (1 is potentially serious!) 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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