Rizhao PortLtd (SHSE:600017) Use Of Debt Could Be Considered Risky

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Rizhao Port Co.,Ltd (SHSE:600017) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Rizhao PortLtd

How Much Debt Does Rizhao PortLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Rizhao PortLtd had CN¥13.8b of debt, an increase on CN¥12.3b, over one year. However, it does have CN¥1.48b in cash offsetting this, leading to net debt of about CN¥12.3b.

How Strong Is Rizhao PortLtd's Balance Sheet?

The latest balance sheet data shows that Rizhao PortLtd had liabilities of CN¥8.75b due within a year, and liabilities of CN¥14.7b falling due after that. Offsetting these obligations, it had cash of CN¥1.48b as well as receivables valued at CN¥1.14b due within 12 months. So its liabilities total CN¥20.9b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥9.63b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Rizhao PortLtd would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Rizhao PortLtd's debt is 4.6 times its EBITDA, and its EBIT cover its interest expense 2.7 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Notably, Rizhao PortLtd's EBIT was pretty flat over the last year, which isn't ideal given the debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Rizhao PortLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Rizhao PortLtd recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

To be frank both Rizhao PortLtd's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. We should also note that Infrastructure industry companies like Rizhao PortLtd commonly do use debt without problems. Taking into account all the aforementioned factors, it looks like Rizhao PortLtd has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. Case in point: We've spotted 2 warning signs for Rizhao PortLtd you should be aware of, and 1 of them is significant.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.