Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” So it seems like smart money knows that debt – which is usually linked to bankruptcies – is a very important factor when you assess the risk of a business. We can see that China YuHua Education Corporation Limited (HKG: 6169) uses debt in his business. But should shareholders be worried about its use of debt?
What risk does debt entail?
Generally speaking, debt only becomes a real problem when a business cannot easily repay it, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to issue shares at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, many companies use debt to finance growth without any negative consequences. When we think of a business’s use of debt, we first look at cash flow and debt together.
Check out our latest analysis for China YuHua Education
What is the net debt of China YuHua Education?
You can click on the graph below for the historical figures, but it shows that in February 2021, China YuHua Education had a debt of 2.85 billion yen, an increase of 2.33 billion yen over one year. However, because it has a cash reserve of 1.78 billion yen, its net debt is less, at around 1.07 billion yen.
How strong is China YuHua Education’s balance sheet?
Zooming in on the latest balance sheet data, we can see that China YuHua Education had liabilities of 2.00 billion yen owed within 12 months and liabilities of 3.32 billion yen beyond. In return, he had 1.78 billion yen in cash and 75.5 million yen in receivables due within 12 months. Its liabilities therefore total 3.46 billion yen more than the combination of its cash and short-term receivables.
Considering that China YuHua Education has a market capitalization of 22.0 billion yen, it is hard to believe that these liabilities pose a significant threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) cover his interests. costs (interest coverage). Thus, we look at debt versus earnings with and without amortization charges.
China YuHua Education’s net debt is only 0.77 times its EBITDA. And its EBIT covers its interest costs 22.0 times more. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. In addition, China YuHua Education has increased its EBIT by 97% over the past twelve months, and this growth will make it easier to manage its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether China YuHua Education can strengthen its balance sheet over time. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.
Finally, while the tax authorities love accounting profits, lenders only accept cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. In the past three years, China YuHua Education has actually produced more free cash flow than EBIT. This kind of big cash conversion turns us on as much as the crowd when the beat drops at a Daft Punk concert.
Our point of view
China YuHua Education’s interest coverage suggests she can manage her debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And the good news does not end there, because its conversion of EBIT into free cash flow also confirms this impression! Considering this range of factors, it seems to us that China YuHua Education is quite conservative with its debt, and the risks appear to be well managed. We are therefore not worried about the use of a small leverage effect on the balance sheet. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 3 warning signs for China YuHua Education you have to be aware of it.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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