$YANGZIJIANG SHIPBLDG HLDGS LTD(BS6.SI)$
Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Yangzijiang Shipbuilding (Holdings) Ltd. (SGX:BS6) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Yangzijiang Shipbuilding (Holdings) Carry?
As you can see below, at the end of December 2021, Yangzijiang Shipbuilding (Holdings) had CN¥4.46b of debt, up from CN¥4.24b a year ago. Click the image for more detail. But on the other hand it also has CN¥28.6b in cash, leading to a CN¥24.1b net cash position.
How Healthy Is Yangzijiang Shipbuilding (Holdings)'s Balance Sheet?
According to the last reported balance sheet, Yangzijiang Shipbuilding (Holdings) had liabilities of CN¥11.8b due within 12 months, and liabilities of CN¥3.75b due beyond 12 months. Offsetting these obligations, it had cash of CN¥28.6b as well as receivables valued at CN¥5.91b due within 12 months. So it can boast CN¥18.9b more liquid assets than total liabilities.
This excess liquidity is a great indication that Yangzijiang Shipbuilding (Holdings)'s balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Yangzijiang Shipbuilding (Holdings) boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that Yangzijiang Shipbuilding (Holdings) has seen its EBIT plunge 15% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Yangzijiang Shipbuilding (Holdings)'s ability to maintain a healthy balance sheet going forward.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Yangzijiang Shipbuilding (Holdings) has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Yangzijiang Shipbuilding (Holdings) recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
Summing up
While it is always sensible to investigate a company's debt, in this case Yangzijiang Shipbuilding (Holdings) has CN¥24.1b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥5.5b, being 82% of its EBIT. So is Yangzijiang Shipbuilding (Holdings)'s debt a risk? It doesn't seem so to us.
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