David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Yihai Kerry Arawana Holdings Co., Ltd (SZSE:300999) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Yihai Kerry Arawana Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Yihai Kerry Arawana Holdings had CN¥94.3b of debt in June 2024, down from CN¥121.7b, one year before. However, it also had CN¥62.3b in cash, and so its net debt is CN¥32.0b.

How Strong Is Yihai Kerry Arawana Holdings' Balance Sheet?

According to the last reported balance sheet, Yihai Kerry Arawana Holdings had liabilities of CN¥108.9b due within 12 months, and liabilities of CN¥7.57b due beyond 12 months. Offsetting these obligations, it had cash of CN¥62.3b as well as receivables valued at CN¥12.9b due within 12 months. So it has liabilities totalling CN¥41.3b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Yihai Kerry Arawana Holdings is worth a massive CN¥136.1b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Strangely Yihai Kerry Arawana Holdings has a sky high EBITDA ratio of 5.9, implying high debt, but a strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Notably, Yihai Kerry Arawana Holdings's EBIT launched higher than Elon Musk, gaining a whopping 713% on last year. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Yihai Kerry Arawana Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Yihai Kerry Arawana Holdings burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

We weren't impressed with Yihai Kerry Arawana Holdings's net debt to EBITDA, and its conversion of EBIT to free cash flow made us cautious. But like a ballerina ending on a perfect pirouette, it has not trouble covering its interest expense with its EBIT. Looking at all this data makes us feel a little cautious about Yihai Kerry Arawana Holdings's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Yihai Kerry Arawana Holdings's earnings per share history for free.

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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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.