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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Yuan Heng Gas Holdings Limited (HKG:332) does use debt in its business. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Yuan Heng Gas Holdings
What Is Yuan Heng Gas Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2019 Yuan Heng Gas Holdings had debt of CN¥1.38b, up from CN¥622.7m in one year. However, it also had CN¥75.2m in cash, and so its net debt is CN¥1.31b.
How Healthy Is Yuan Heng Gas Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Yuan Heng Gas Holdings had liabilities of CN¥2.76b due within 12 months and liabilities of CN¥356.4m due beyond that. Offsetting this, it had CN¥75.2m in cash and CN¥2.61b in receivables that were due within 12 months. So its liabilities total CN¥428.2m more than the combination of its cash and short-term receivables.
Since publicly traded Yuan Heng Gas Holdings shares are worth a total of CN¥3.02b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.