Is Jiayuan International Group (HKG: 2768) Using Too Much Debt?
Howard Marks put it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We can see that Jiayuan International Group Limited (HKG: 2768) uses debt in its business. But does this debt worry shareholders?
What risk does debt entail?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a business’s debt levels is to consider its cash flow and debt together.
See our latest analysis for Jiayuan International Group
What is the debt of the Jiayuan International group?
As you can see below, at the end of June 2021, Jiayuan International Group was in debt of CND 24.6 billion, compared to CNN 20.3 billion a year ago. Click on the image for more details. However, given that it has a cash reserve of CN 10.6 billion, its net debt is lower, at around CN 14.0 billion.
How strong is Jiayuan International Group’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Jiayuan International Group had liabilities of 47.7 billion yen due within 12 months and liabilities of 15.9 billion yen beyond. On the other hand, he had CN 10.6 billion in cash and CN 1.14 billion in receivables due within one year. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by CN ¥ 51.9b.
This deficit casts a shadow over the CN ¥ 11.5b company, like a colossus towering above mere mortals. We therefore believe that shareholders should monitor it closely. Ultimately, Jiayuan International Group would likely need a major recapitalization if its creditors demanded repayment.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Jiayuan International Group has a debt to EBITDA ratio of 2.9, which signals significant debt, but is still fairly reasonable for most types of businesses. However, its interest coverage of 1k is very high, which suggests that interest charges on debt are currently quite low. Unfortunately, Jiayuan International Group’s EBIT has fallen 10% in the past four quarters. If incomes continue to decline at this rate, it will be more difficult to manage debt than taking three kids under 5 to a fancy pants restaurant. There is no doubt that we learn the most about debt from the balance sheet. But it is future profits, more than anything, that will determine Jiayuan International Group’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Jiayuan International Group has generated strong free cash flow equivalent to 67% of its EBIT, roughly what we expected. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
Reflecting on Jiayuan International Group’s attempt to stay on top of its total liabilities, we are certainly not enthusiastic. But on the bright side, his interest coverage is a good sign and makes us more optimistic. Overall, we think it’s fair to say that Jiayuan International Group has enough debt that there is real risk around its balance sheet. If all goes well, this should increase returns, but on the other hand, the risk of permanent capital loss is increased by debt. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risks lie on the balance sheet – far from it. To this end, you should inquire about the 3 warning signs we spotted with Jiayuan International Group (including 1 which is potentially serious).
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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