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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Yunnan Tourism Co., Ltd. (SZSE:002059) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Yunnan Tourism
What Is Yunnan Tourism's Net Debt?
As you can see below, Yunnan Tourism had CN¥973.6m of debt at September 2023, down from CN¥1.09b a year prior. However, it does have CN¥915.9m in cash offsetting this, leading to net debt of about CN¥57.7m.
How Healthy Is Yunnan Tourism's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Yunnan Tourism had liabilities of CN¥1.78b due within 12 months and liabilities of CN¥911.5m due beyond that. Offsetting these obligations, it had cash of CN¥915.9m as well as receivables valued at CN¥432.6m due within 12 months. So it has liabilities totalling CN¥1.34b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Yunnan Tourism has a market capitalization of CN¥4.96b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Carrying virtually no net debt, Yunnan Tourism has a very light debt load indeed. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Yunnan Tourism will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Yunnan Tourism had a loss before interest and tax, and actually shrunk its revenue by 51%, to CN¥435m. To be frank that doesn't bode well.
Caveat Emptor
Not only did Yunnan Tourism's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥366m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥25m of cash over the last year. So suffice it to say we do consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Yunnan Tourism you should know about.
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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