Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that YOUNGY Co., Ltd. (SZSE:002192) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does YOUNGY Carry?
As you can see below, at the end of March 2024, YOUNGY had CN¥100.1m of debt, up from CN¥66.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.51b in cash, so it actually has CN¥1.41b net cash.
How Strong Is YOUNGY's Balance Sheet?
We can see from the most recent balance sheet that YOUNGY had liabilities of CN¥482.3m falling due within a year, and liabilities of CN¥453.0m due beyond that. On the other hand, it had cash of CN¥1.51b and CN¥280.6m worth of receivables due within a year. So it actually has CN¥855.9m more liquid assets than total liabilities.
This surplus suggests that YOUNGY has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that YOUNGY has more cash than debt is arguably a good indication that it can manage its debt safely.
It is just as well that YOUNGY's load is not too heavy, because its EBIT was down 80% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if YOUNGY 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. YOUNGY 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 most recent three years, YOUNGY recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that YOUNGY has net cash of CN¥1.41b, as well as more liquid assets than liabilities. The cherry on top was that in converted 66% of that EBIT to free cash flow, bringing in CN¥159m. So we don't have any problem with YOUNGY's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for YOUNGY you should be aware of.
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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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.