We Think Asia-potash International Investment (Guangzhou)Co.Ltd (SZSE:000893) Is Taking Some Risk With Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Asia-potash International Investment (Guangzhou)Co.,Ltd. (SZSE:000893) makes use of debt. But should shareholders be worried about its use of debt?

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When Is Debt A Problem?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Asia-potash International Investment (Guangzhou)Co.Ltd's Debt?

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. However, it also had CN¥700.1m in cash, and so its net debt is CN¥1.38b.

How Strong 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¥2.56b due within a year, and liabilities of CN¥1.82b falling due after that. Offsetting these obligations, it had cash of CN¥700.1m as well as receivables valued at CN¥43.1m due within 12 months. So its liabilities total CN¥3.64b more than the combination of its cash and short-term receivables.

Of course, Asia-potash International Investment (Guangzhou)Co.Ltd has a market capitalization of CN¥22.9b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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

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). 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 0.90 times its EBITDA. And its EBIT covers its interest expense a whopping 48.3 times over. 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 44% in the last twelve months. 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 always check how much of that EBIT is translated into free cash flow. Over the last three years, Asia-potash International Investment (Guangzhou)Co.Ltd saw substantial negative free cash flow, in total. 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. While that debt can boost returns, we think the company has enough leverage now. 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. We've identified 1 warning sign with Asia-potash International Investment (Guangzhou)Co.Ltd , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.