Asia-potash International Investment (Guangzhou)Co.Ltd (SZSE:000893) Has A Somewhat Strained Balance Sheet

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Asia-potash International Investment (Guangzhou)Co.,Ltd. (SZSE:000893) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Asia-potash International Investment (Guangzhou)Co.Ltd

How Much Debt Does Asia-potash International Investment (Guangzhou)Co.Ltd Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Asia-potash International Investment (Guangzhou)Co.Ltd had debt of CN¥1.84b, up from none in one year. On the flip side, it has CN¥564.4m in cash leading to net debt of about CN¥1.27b.

How Healthy Is Asia-potash International Investment (Guangzhou)Co.Ltd's Balance Sheet?

The latest balance sheet data shows that Asia-potash International Investment (Guangzhou)Co.Ltd had liabilities of CN¥2.08b due within a year, and liabilities of CN¥1.64b falling due after that. Offsetting this, it had CN¥564.4m in cash and CN¥127.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.04b.

Since publicly traded Asia-potash International Investment (Guangzhou)Co.Ltd shares are worth a total of CN¥16.8b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

Asia-potash International Investment (Guangzhou)Co.Ltd's net debt is only 0.76 times its EBITDA. And its EBIT covers its interest expense a whopping 115 times over. So we're pretty relaxed about its super-conservative use of debt. The modesty of its debt load may become crucial for Asia-potash International Investment (Guangzhou)Co.Ltd if management cannot prevent a repeat of the 48% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Asia-potash International Investment (Guangzhou)Co.Ltd 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. During the last three years, Asia-potash International Investment (Guangzhou)Co.Ltd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Asia-potash International Investment (Guangzhou)Co.Ltd's EBIT growth rate and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. When we consider all the factors discussed, it seems to us that Asia-potash International Investment (Guangzhou)Co.Ltd is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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 2 warning signs for Asia-potash International Investment (Guangzhou)Co.Ltd (of which 1 is significant!) 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.