We Think Yungshin Construction & DevelopmentLtd (GTSM:5508) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Yungshin Construction & Development Co.,Ltd. (GTSM:5508) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Yungshin Construction & DevelopmentLtd

How Much Debt Does Yungshin Construction & DevelopmentLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Yungshin Construction & DevelopmentLtd had NT$5.55b of debt, an increase on NT$4.66b, over one year. However, it also had NT$154.8m in cash, and so its net debt is NT$5.39b.

A Look At Yungshin Construction & DevelopmentLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Yungshin Construction & DevelopmentLtd had liabilities of NT$5.18b due within 12 months and liabilities of NT$1.19b due beyond that. Offsetting these obligations, it had cash of NT$154.8m as well as receivables valued at NT$41.2m due within 12 months. So it has liabilities totalling NT$6.18b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of NT$9.90b, so it does suggest shareholders should keep an eye on Yungshin Construction & DevelopmentLtd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

As it happens Yungshin Construction & DevelopmentLtd has a fairly concerning net debt to EBITDA ratio of 6.4 but very strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! It is well worth noting that Yungshin Construction & DevelopmentLtd's EBIT shot up like bamboo after rain, gaining 86% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Yungshin Construction & DevelopmentLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Yungshin Construction & DevelopmentLtd 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 Yungshin Construction & DevelopmentLtd'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. Looking at all the angles mentioned above, it does seem to us that Yungshin Construction & DevelopmentLtd is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. Be aware that Yungshin Construction & DevelopmentLtd is showing 2 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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