Does Hua Yu Lien Development (TPE:1436) Have A Healthy 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.' 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. Importantly, Hua Yu Lien Development Co., Ltd (TPE:1436) does carry debt. But is this debt a concern to shareholders?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hua Yu Lien Development

What Is Hua Yu Lien Development's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Hua Yu Lien Development had NT$7.17b of debt, an increase on NT$6.43b, over one year. However, because it has a cash reserve of NT$462.4m, its net debt is less, at about NT$6.71b.

How Healthy Is Hua Yu Lien Development's Balance Sheet?

We can see from the most recent balance sheet that Hua Yu Lien Development had liabilities of NT$6.10b falling due within a year, and liabilities of NT$2.38b due beyond that. Offsetting these obligations, it had cash of NT$462.4m as well as receivables valued at NT$22.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$7.99b.

The deficiency here weighs heavily on the NT$3.65b 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, Hua Yu Lien Development 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).

Hua Yu Lien Development has a rather high debt to EBITDA ratio of 11.4 which suggests a meaningful debt load. However, its interest coverage of 5.6 is reasonably strong, which is a good sign. Pleasingly, Hua Yu Lien Development is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 133% 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 Hua Yu Lien Development can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last three years, Hua Yu Lien Development saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Hua Yu Lien Development's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Hua Yu Lien Development to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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 2 warning signs for Hua Yu Lien Development you should be aware of, and 1 of them 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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This article by Simply Wall St is general in nature. 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.
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