Hi-Yes International (TWSE:2348) Takes On Some Risk With Its Use Of Debt

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.' 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 Hi-Yes International Co., Ltd. (TWSE:2348) makes use of debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hi-Yes International

What Is Hi-Yes International's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Hi-Yes International had debt of NT$23.0b, up from NT$16.3b in one year. However, it does have NT$5.98b in cash offsetting this, leading to net debt of about NT$17.0b.

A Look At Hi-Yes International's Liabilities

We can see from the most recent balance sheet that Hi-Yes International had liabilities of NT$10.2b falling due within a year, and liabilities of NT$20.4b due beyond that. Offsetting this, it had NT$5.98b in cash and NT$2.76b in receivables that were due within 12 months. So it has liabilities totalling NT$21.9b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of NT$26.3b, so it does suggest shareholders should keep an eye on Hi-Yes International's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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.

Strangely Hi-Yes International has a sky high EBITDA ratio of 5.2, implying high debt, but a strong interest coverage of 20.9. So either it has access to very cheap long term debt or that interest expense is going to grow! Pleasingly, Hi-Yes International is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 125% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hi-Yes International can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Hi-Yes International 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

We feel some trepidation about Hi-Yes International's difficulty conversion of EBIT to free cash flow, but we've got positives to focus on, too. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. Taking the abovementioned factors together we do think Hi-Yes International's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 5 warning signs for Hi-Yes International you should be aware of, and 4 of them can't be ignored.

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.