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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Yancoal Australia Ltd (ASX:YAL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Yancoal Australia
What Is Yancoal Australia's Net Debt?
As you can see below, Yancoal Australia had AU$3.40b of debt at June 2019, down from AU$4.28b a year prior. However, it also had AU$590.0m in cash, and so its net debt is AU$2.81b.
How Strong Is Yancoal Australia's Balance Sheet?
We can see from the most recent balance sheet that Yancoal Australia had liabilities of AU$1.24b falling due within a year, and liabilities of AU$3.57b due beyond that. Offsetting these obligations, it had cash of AU$590.0m as well as receivables valued at AU$481.0m due within 12 months. So its liabilities total AU$3.74b more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of AU$3.93b. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Yancoal Australia has net debt worth 1.5 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 5.3 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. It is well worth noting that Yancoal Australia's EBIT shot up like bamboo after rain, gaining 56% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Yancoal Australia's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.