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Here's Why Hua Yin International Holdings (HKG:989) Can Afford Some Debt

Simply Wall St ·  08/02 11:30

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Hua Yin International Holdings Limited (HKG:989) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Hua Yin International Holdings

What Is Hua Yin International Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Hua Yin International Holdings had debt of CN¥1.03b, up from CN¥945.6m in one year. On the flip side, it has CN¥93.2m in cash leading to net debt of about CN¥932.5m.

debt-equity-history-analysisSEHK:989 Debt to Equity History August 2nd 2022

How Strong Is Hua Yin International Holdings' Balance Sheet?

The latest balance sheet data shows that Hua Yin International Holdings had liabilities of CN¥1.58b due within a year, and liabilities of CN¥450.7m falling due after that. Offsetting these obligations, it had cash of CN¥93.2m as well as receivables valued at CN¥55.7m due within 12 months. So its liabilities total CN¥1.88b more than the combination of its cash and short-term receivables.

Hua Yin International Holdings has a market capitalization of CN¥3.16b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Hua Yin International Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Hua Yin International Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥112m, which is a fall of 27%. To be frank that doesn't bode well.

Caveat Emptor

While Hua Yin International Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CN¥4.0m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥97m of cash over the last year. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Hua Yin International Holdings (at least 2 which are significant) , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.

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