Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Hebei Yichen Industrial Group Corporation Limited (HKG:1596) makes use of debt. But is this debt a concern to shareholders?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Hebei Yichen Industrial Group Carry?
You can click the graphic below for the historical numbers, but it shows that Hebei Yichen Industrial Group had CN¥124.8m of debt in December 2018, down from CN¥366.9m, one year before. However, its balance sheet shows it holds CN¥278.9m in cash, so it actually has CN¥154.1m net cash.
How Strong Is Hebei Yichen Industrial Group's Balance Sheet?
We can see from the most recent balance sheet that Hebei Yichen Industrial Group had liabilities of CN¥584.2m falling due within a year, and liabilities of CN¥35.6m due beyond that. Offsetting this, it had CN¥278.9m in cash and CN¥1.28b in receivables that were due within 12 months. So it actually has CN¥934.9m more liquid assets than total liabilities.
This surplus strongly suggests that Hebei Yichen Industrial Group has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Succinctly put, Hebei Yichen Industrial Group boasts net cash, so it's fair to say it does not have a heavy debt load!
But the other side of the story is that Hebei Yichen Industrial Group saw its EBIT decline by 5.9% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hebei Yichen Industrial Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Hebei Yichen Industrial Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Hebei Yichen Industrial Group recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for and improvement.
While it is always sensible to investigate a company's debt, in this case Hebei Yichen Industrial Group has CN¥154m in net cash and a decent-looking balance sheet. So we don't have any problem with Hebei Yichen Industrial Group's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Hebei Yichen Industrial Group insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.