The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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 Yuk Wing Group Holdings Limited (HKG:1536) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Yuk Wing Group Holdings's Net Debt?
As you can see below, Yuk Wing Group Holdings had HK$26.4m of debt at September 2019, down from HK$30.1m a year prior. However, its balance sheet shows it holds HK$83.2m in cash, so it actually has HK$56.8m net cash.
A Look At Yuk Wing Group Holdings's Liabilities
We can see from the most recent balance sheet that Yuk Wing Group Holdings had liabilities of HK$49.7m falling due within a year, and liabilities of HK$15.5m due beyond that. Offsetting this, it had HK$83.2m in cash and HK$78.3m in receivables that were due within 12 months. So it can boast HK$96.3m more liquid assets than total liabilities.
This excess liquidity is a great indication that Yuk Wing Group Holdings's balance sheet is just as strong as racists are weak. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Succinctly put, Yuk Wing Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Yuk Wing Group Holdings grew its EBIT by 115% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Yuk Wing Group Holdings'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Yuk Wing Group Holdings 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. During the last three years, Yuk Wing Group Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While we empathize with investors who find debt concerning, you should keep in mind that Yuk Wing Group Holdings has net cash of HK$56.8m, as well as more liquid assets than liabilities. And we liked the look of last year's 115% year-on-year EBIT growth. So is Yuk Wing Group Holdings's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Yuk Wing Group Holdings is showing 2 warning signs in our investment analysis , and 1 of those is potentially serious...
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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.
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