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 Yuneng Technology Co., Ltd. (SHSE:688348) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Yuneng Technology's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Yuneng Technology had debt of CN¥1.12b, up from CN¥53.2m in one year. However, it does have CN¥2.51b in cash offsetting this, leading to net cash of CN¥1.39b.
How Strong Is Yuneng Technology's Balance Sheet?
We can see from the most recent balance sheet that Yuneng Technology had liabilities of CN¥1.41b falling due within a year, and liabilities of CN¥124.2m due beyond that. Offsetting this, it had CN¥2.51b in cash and CN¥305.2m in receivables that were due within 12 months. So it actually has CN¥1.28b more liquid assets than total liabilities.
This short term liquidity is a sign that Yuneng Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Yuneng Technology has more cash than debt is arguably a good indication that it can manage its debt safely.
It is just as well that Yuneng Technology's load is not too heavy, because its EBIT was down 27% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Yuneng Technology can strengthen its balance sheet over time. 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. Yuneng Technology 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 last three years, Yuneng Technology saw substantial negative free cash flow, in total. 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.
Summing Up
While it is always sensible to investigate a company's debt, in this case Yuneng Technology has CN¥1.39b in net cash and a decent-looking balance sheet. So while Yuneng Technology does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Yuneng Technology you should be aware of.
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.