These 4 Measures Indicate That Asia-potash International Investment (Guangzhou)Co.Ltd (SZSE:000893) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Asia-potash International Investment (Guangzhou)Co.,Ltd. (SZSE:000893) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out 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 September 2024 Asia-potash International Investment (Guangzhou)Co.Ltd had debt of CN¥2.08b, up from CN¥526.6m in one year. On the flip side, it has CN¥700.1m in cash leading to net debt of about CN¥1.38b.

A Look At Asia-potash International Investment (Guangzhou)Co.Ltd's Liabilities

According to the last reported balance sheet, Asia-potash International Investment (Guangzhou)Co.Ltd had liabilities of CN¥2.56b due within 12 months, and liabilities of CN¥1.82b due beyond 12 months. On the other hand, it had cash of CN¥700.1m and CN¥43.1m worth of receivables due within a year. So its liabilities total CN¥3.64b more than the combination of its cash and short-term receivables.

Since publicly traded Asia-potash International Investment (Guangzhou)Co.Ltd shares are worth a total of CN¥19.3b, 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.

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).

Asia-potash International Investment (Guangzhou)Co.Ltd has a low net debt to EBITDA ratio of only 0.90. And its EBIT covers its interest expense a whopping 48.3 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 44% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 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

Neither Asia-potash International Investment (Guangzhou)Co.Ltd's ability to grow its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. Taking the abovementioned factors together we do think Asia-potash International Investment (Guangzhou)Co.Ltd's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Asia-potash International Investment (Guangzhou)Co.Ltd is showing 1 warning sign in our investment analysis , you should know about...

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.