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. Importantly, Yantai Shuangta Food Co., Ltd. (SZSE:002481) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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 examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Yantai Shuangta Food Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Yantai Shuangta Food had CN¥958.4m of debt, an increase on CN¥853.1m, over one year. However, because it has a cash reserve of CN¥669.3m, its net debt is less, at about CN¥289.1m.

How Strong Is Yantai Shuangta Food's Balance Sheet?

According to the last reported balance sheet, Yantai Shuangta Food had liabilities of CN¥1.26b due within 12 months, and liabilities of CN¥218.6m due beyond 12 months. On the other hand, it had cash of CN¥669.3m and CN¥315.0m worth of receivables due within a year. So it has liabilities totalling CN¥494.3m more than its cash and near-term receivables, combined.

Of course, Yantai Shuangta Food has a market capitalization of CN¥5.16b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Yantai Shuangta Food's net debt is only 0.87 times its EBITDA. And its EBIT easily covers its interest expense, being 47.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. It was also good to see that despite losing money on the EBIT line last year, Yantai Shuangta Food turned things around in the last 12 months, delivering and EBIT of CN¥178m. 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 Shuangta Food will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the most recent year, Yantai Shuangta Food recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Yantai Shuangta Food's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! When we consider the range of factors above, it looks like Yantai Shuangta Food is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Yantai Shuangta Food (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.