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.' 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. As with many other companies Yangtze Optical Fibre And Cable Joint Stock Limited Company (HKG:6869) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is Yangtze Optical Fibre And Cable Limited's Net Debt?
As you can see below, at the end of March 2019, Yangtze Optical Fibre And Cable Limited had CN¥1.33b of debt, up from CN¥1.03b a year ago. Click the image for more detail. But it also has CN¥2.17b in cash to offset that, meaning it has CN¥840.5m net cash.
How Strong Is Yangtze Optical Fibre And Cable Limited's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Yangtze Optical Fibre And Cable Limited had liabilities of CN¥3.41b due within 12 months and liabilities of CN¥1.10b due beyond that. Offsetting this, it had CN¥2.17b in cash and CN¥3.59b in receivables that were due within 12 months. So it actually has CN¥1.24b more liquid assets than total liabilities.
This surplus suggests that Yangtze Optical Fibre And Cable Limited has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Yangtze Optical Fibre And Cable Limited boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that Yangtze Optical Fibre And Cable Limited has seen its EBIT plunge 18% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Yangtze Optical Fibre And Cable Limited can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Yangtze Optical Fibre And Cable Limited may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Yangtze Optical Fibre And Cable Limited reported free cash flow worth 9.1% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Yangtze Optical Fibre And Cable Limited has net cash of CN¥841m, as well as more liquid assets than liabilities. So we are not troubled with Yangtze Optical Fibre And Cable Limited's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Yangtze Optical Fibre And Cable Limited insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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