Does Zhuhai PortLtd (SZSE:000507) Have A Healthy Balance Sheet?

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.' 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, Zhuhai Port Co.,Ltd. (SZSE:000507) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Zhuhai PortLtd

What Is Zhuhai PortLtd's Net Debt?

As you can see below, Zhuhai PortLtd had CN¥8.58b of debt at September 2024, down from CN¥9.63b a year prior. However, it does have CN¥2.62b in cash offsetting this, leading to net debt of about CN¥5.97b.

A Look At Zhuhai PortLtd's Liabilities

We can see from the most recent balance sheet that Zhuhai PortLtd had liabilities of CN¥4.24b falling due within a year, and liabilities of CN¥6.47b due beyond that. On the other hand, it had cash of CN¥2.62b and CN¥1.80b worth of receivables due within a year. So it has liabilities totalling CN¥6.29b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥5.02b, we think shareholders really should watch Zhuhai PortLtd's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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.

As it happens Zhuhai PortLtd has a fairly concerning net debt to EBITDA ratio of 5.4 but very strong interest coverage of 19.8. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Sadly, Zhuhai PortLtd's EBIT actually dropped 9.4% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. 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 Zhuhai PortLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Zhuhai PortLtd actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

While Zhuhai PortLtd's net debt to EBITDA has us nervous. For example, its interest cover and conversion of EBIT to free cash flow give us some confidence in its ability to manage its debt. We should also note that Infrastructure industry companies like Zhuhai PortLtd commonly do use debt without problems. Taking the abovementioned factors together we do think Zhuhai PortLtd's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. To that end, you should be aware of the 1 warning sign we've spotted with Zhuhai PortLtd .

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.