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

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. Importantly, Asia-potash International Investment (Guangzhou)Co.,Ltd. (SZSE:000893) does carry debt. But is this debt a concern to shareholders?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, 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?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Asia-potash International Investment (Guangzhou)Co.Ltd had CN¥1.94b of debt, an increase on CN¥132.5m, over one year. On the flip side, it has CN¥590.0m in cash leading to net debt of about CN¥1.35b.

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

According to the last reported balance sheet, Asia-potash International Investment (Guangzhou)Co.Ltd had liabilities of CN¥2.23b due within 12 months, and liabilities of CN¥1.78b due beyond 12 months. Offsetting this, it had CN¥590.0m in cash and CN¥115.0m in receivables that were due within 12 months. So it has liabilities totalling CN¥3.30b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Asia-potash International Investment (Guangzhou)Co.Ltd has a market capitalization of CN¥13.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Asia-potash International Investment (Guangzhou)Co.Ltd's net debt is only 0.96 times its EBITDA. And its EBIT easily covers its interest expense, being 55.1 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In fact Asia-potash International Investment (Guangzhou)Co.Ltd's saving grace is its low debt levels, because its EBIT has tanked 48% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Asia-potash International Investment (Guangzhou)Co.Ltd's ability to maintain a healthy balance sheet going forward. 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 always check how much of that EBIT is translated into free cash flow. During the last three years, Asia-potash International Investment (Guangzhou)Co.Ltd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Asia-potash International Investment (Guangzhou)Co.Ltd's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Asia-potash International Investment (Guangzhou)Co.Ltd's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Asia-potash International Investment (Guangzhou)Co.Ltd (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.