These 4 Measures Indicate That YungShin Global Holding (TPE:3705) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that YungShin Global Holding Corporation (TPE:3705) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. 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.

View our latest analysis for YungShin Global Holding

What Is YungShin Global Holding's Net Debt?

As you can see below, YungShin Global Holding had NT$3.57b of debt at September 2020, down from NT$3.88b a year prior. However, it also had NT$1.23b in cash, and so its net debt is NT$2.33b.

How Strong Is YungShin Global Holding's Balance Sheet?

We can see from the most recent balance sheet that YungShin Global Holding had liabilities of NT$4.59b falling due within a year, and liabilities of NT$1.37b due beyond that. Offsetting these obligations, it had cash of NT$1.23b as well as receivables valued at NT$1.76b due within 12 months. So it has liabilities totalling NT$2.96b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since YungShin Global Holding has a market capitalization of NT$11.6b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

YungShin Global Holding's net debt to EBITDA ratio of about 1.7 suggests only moderate use of debt. And its strong interest cover of 20.0 times, makes us even more comfortable. Another good sign is that YungShin Global Holding has been able to increase its EBIT by 25% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is YungShin Global Holding's earnings that will influence how the balance sheet holds up in the future. 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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, YungShin Global Holding recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that YungShin Global Holding's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Taking all this data into account, it seems to us that YungShin Global Holding takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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 YungShin Global Holding (1 is a bit unpleasant!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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