These 4 Measures Indicate That Beijing-Shanghai High-Speed Railway (SHSE:601816) Is Using Debt Safely

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Beijing-Shanghai High-Speed Railway Co., Ltd. (SHSE:601816) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Beijing-Shanghai High-Speed Railway

How Much Debt Does Beijing-Shanghai High-Speed Railway Carry?

The image below, which you can click on for greater detail, shows that Beijing-Shanghai High-Speed Railway had debt of CN¥53.2b at the end of September 2024, a reduction from CN¥68.6b over a year. However, because it has a cash reserve of CN¥7.50b, its net debt is less, at about CN¥45.7b.

How Healthy Is Beijing-Shanghai High-Speed Railway's Balance Sheet?

We can see from the most recent balance sheet that Beijing-Shanghai High-Speed Railway had liabilities of CN¥8.65b falling due within a year, and liabilities of CN¥51.9b due beyond that. Offsetting this, it had CN¥7.50b in cash and CN¥1.87b in receivables that were due within 12 months. So its liabilities total CN¥51.2b more than the combination of its cash and short-term receivables.

Given Beijing-Shanghai High-Speed Railway has a humongous market capitalization of CN¥277.5b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). 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).

We'd say that Beijing-Shanghai High-Speed Railway's moderate net debt to EBITDA ratio ( being 1.8), indicates prudence when it comes to debt. And its strong interest cover of 10.0 times, makes us even more comfortable. It is well worth noting that Beijing-Shanghai High-Speed Railway's EBIT shot up like bamboo after rain, gaining 42% in the last twelve months. That'll make it easier to manage its debt. 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 Beijing-Shanghai High-Speed Railway's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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, Beijing-Shanghai High-Speed Railway actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, Beijing-Shanghai High-Speed Railway's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! Zooming out, Beijing-Shanghai High-Speed Railway seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Beijing-Shanghai High-Speed Railway 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.