Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Yantai North Andre Juice Company Limited (HKG:2218) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.
How Much Debt Does Yantai North Andre Juice Carry?
The image below, which you can click on for greater detail, shows that Yantai North Andre Juice had debt of CN¥846.9k at the end of June 2019, a reduction from CN¥20.9m over a year. However, its balance sheet shows it holds CN¥649.5m in cash, so it actually has CN¥648.6m net cash.
How Strong Is Yantai North Andre Juice's Balance Sheet?
We can see from the most recent balance sheet that Yantai North Andre Juice had liabilities of CN¥105.2m falling due within a year, and liabilities of CN¥1.71m due beyond that. Offsetting this, it had CN¥649.5m in cash and CN¥168.3m in receivables that were due within 12 months. So it can boast CN¥710.9m more liquid assets than total liabilities.
This luscious liquidity implies that Yantai North Andre Juice's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Simply put, the fact that Yantai North Andre Juice has more cash than debt is arguably a good indication that it can manage its debt safely.
But the other side of the story is that Yantai North Andre Juice saw its EBIT decline by 5.2% 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 you can't view debt in total isolation; since Yantai North Andre Juice will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Yantai North Andre Juice 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. Happily for any shareholders, Yantai North Andre Juice actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While we empathize with investors who find debt concerning, you should keep in mind that Yantai North Andre Juice has net cash of CN¥648.6m, as well as more liquid assets than liabilities. The cherry on top was that in converted 195% of that EBIT to free cash flow, bringing in CN¥347m. So is Yantai North Andre Juice's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Yantai North Andre Juice would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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