Yuen Chang Stainless Steel (TWSE:2069) Has A Somewhat Strained Balance Sheet

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Yuen Chang Stainless Steel Co., Ltd. (TWSE:2069) makes use of debt. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. 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.

See our latest analysis for Yuen Chang Stainless Steel

What Is Yuen Chang Stainless Steel's Debt?

The image below, which you can click on for greater detail, shows that Yuen Chang Stainless Steel had debt of NT$4.46b at the end of September 2024, a reduction from NT$5.27b over a year. However, because it has a cash reserve of NT$200.0m, its net debt is less, at about NT$4.26b.

How Strong Is Yuen Chang Stainless Steel's Balance Sheet?

According to the last reported balance sheet, Yuen Chang Stainless Steel had liabilities of NT$4.48b due within 12 months, and liabilities of NT$607.0m due beyond 12 months. On the other hand, it had cash of NT$200.0m and NT$1.20b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$3.69b.

Given this deficit is actually higher than the company's market capitalization of NT$3.19b, we think shareholders really should watch Yuen Chang Stainless Steel's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 1.5 times and a disturbingly high net debt to EBITDA ratio of 8.6 hit our confidence in Yuen Chang Stainless Steel like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, the silver lining was that Yuen Chang Stainless Steel achieved a positive EBIT of NT$254m in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But it is Yuen Chang Stainless Steel'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Yuen Chang Stainless Steel actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, Yuen Chang Stainless Steel's interest cover left us tentative about the stock, and its net debt to EBITDA was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Yuen Chang Stainless Steel stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. For example, we've discovered 3 warning signs for Yuen Chang Stainless Steel (1 shouldn't be ignored!) 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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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.