Warren Buffett said: “Volatility is far from synonymous with risk. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Wei Yuan Holdings Limited (HKG:1343) uses debt in his business. But the more important question is: what risk does this debt create?
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
See our latest analysis for Wei Yuan Holdings
How much debt does Wei Yuan Holdings have?
You can click on the graph below for historical figures, but it shows that in December 2021, Wei Yuan Holdings had a debt of S$39.5 million, an increase from S$34.3 million , over one year. However, since it has a cash reserve of S$15.8 million, its net debt is less, at around S$23.7 million.
How healthy is Wei Yuan Holdings’ balance sheet?
The latest balance sheet data shows that Wei Yuan Holdings had liabilities of S$58.1 million due within one year, and liabilities of S$6.41 million falling due thereafter. In return, he had S$15.8 million in cash and S$63.9 million in debt due within 12 months. So he actually has S$15.2 million After liquid assets than total liabilities.
This excess liquidity suggests that Wei Yuan Holdings’ balance sheet could take a hit as well as Homer Simpson’s head may take a hit. With that in mind, one could argue that its track record means the company is capable of dealing with some adversity.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While we are not concerned about Wei Yuan Holdings’ net debt to EBITDA ratio of 3.0, we believe its extremely low interest coverage of 2.2 times is a sign of high leverage. This is largely due to the company’s large amortization charges, which no doubt means that its EBITDA is a very generous measure of earnings, and that its debt may be heavier than it first appears. on board. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. A redeeming factor for Wei Yuan Holdings is that it turned last year’s EBIT loss into a S$2.4 million gain over the past twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; since Wei Yuan Holdings will need income to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. It is therefore important to check how much of its earnings before interest and taxes (EBIT) converts into actual free cash flow. Over the past year, Wei Yuan Holdings has actually produced more free cash flow than EBIT. There’s nothing better than incoming money to stay in the good books of your lenders.
Our point of view
The good news is that Wei Yuan Holdings’ demonstrated ability to convert EBIT into free cash flow delights us like a fluffy puppy does a toddler. But the harsh truth is that we are concerned about his coverage of interests. Overall, we think Wei Yuan Holdings’ use of debt seems entirely reasonable and we are not worried about that. After all, reasonable leverage can increase return on equity. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example, we have identified 4 warning signs for Wei Yuan Holdings (2 doesn’t sit too well with us) you should know.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.