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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. Importantly, Yue Yuen Industrial (Holdings) Limited (HKG:551) does carry debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Yue Yuen Industrial (Holdings)
What Is Yue Yuen Industrial (Holdings)'s Debt?
As you can see below, Yue Yuen Industrial (Holdings) had US$2.05b of debt at June 2019, down from US$2.20b a year prior. However, it does have US$816.3m in cash offsetting this, leading to net debt of about US$1.23b.
How Healthy Is Yue Yuen Industrial (Holdings)'s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Yue Yuen Industrial (Holdings) had liabilities of US$2.21b due within 12 months and liabilities of US$1.58b due beyond that. Offsetting this, it had US$816.3m in cash and US$1.70b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.27b.
Yue Yuen Industrial (Holdings) has a market capitalization of US$4.49b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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). 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).