David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Jiayuan International Group Limited (HKG:2768) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. 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.
Check out our latest analysis for Jiayuan International Group
What Is Jiayuan International Group’s Net Debt?
As you can see below, Jiayuan International Group had CN¥24.9b of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CN¥9.21b in cash leading to net debt of about CN¥15.7b.
How Strong Is Jiayuan International Group’s Balance Sheet?
According to the last reported balance sheet, Jiayuan International Group had liabilities of CN¥42.4b due within 12 months, and liabilities of CN¥17.5b due beyond 12 months. Offsetting these obligations, it had cash of CN¥9.21b as well as receivables valued at CN¥1.04b due within 12 months. So it has liabilities totalling CN¥49.7b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the CN¥4.37b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Jiayuan International Group would probably need a major re-capitalization if its creditors were to demand repayment.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Jiayuan International Group’s net debt is 3.4 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 57.3 is very high, suggesting that the interest expense on the debt is currently quite low. The bad news is that Jiayuan International Group saw its EBIT decline by 15% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Jiayuan International Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Jiayuan International Group recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we’d usually expect. That positions it well to pay down debt if desirable to do so.
On the face of it, Jiayuan International Group’s EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it’s pretty decent at covering its interest expense with its EBIT; that’s encouraging. Once we consider all the factors above, together, it seems to us that Jiayuan International Group’s debt is making it a bit risky. Some people like that sort of risk, but we’re mindful of the potential pitfalls, so we’d probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. Be aware that Jiayuan International Group is showing 3 warning signs in our investment analysis , 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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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.