China Merchants Expressway Network & Technology HoldingsLtd (SZSE:001965) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies China Merchants Expressway Network & Technology Holdings Co.,Ltd. (SZSE:001965) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for China Merchants Expressway Network & Technology HoldingsLtd

What Is China Merchants Expressway Network & Technology HoldingsLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 China Merchants Expressway Network & Technology HoldingsLtd had debt of CN¥57.6b, up from CN¥39.5b in one year. However, because it has a cash reserve of CN¥9.04b, its net debt is less, at about CN¥48.5b.

How Strong Is China Merchants Expressway Network & Technology HoldingsLtd's Balance Sheet?

We can see from the most recent balance sheet that China Merchants Expressway Network & Technology HoldingsLtd had liabilities of CN¥15.7b falling due within a year, and liabilities of CN¥54.4b due beyond that. Offsetting this, it had CN¥9.04b in cash and CN¥4.93b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥56.2b.

This is a mountain of leverage even relative to its gargantuan market capitalization of CN¥81.9b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

As it happens China Merchants Expressway Network & Technology HoldingsLtd has a fairly concerning net debt to EBITDA ratio of 9.2 but very strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! It is well worth noting that China Merchants Expressway Network & Technology HoldingsLtd's EBIT shot up like bamboo after rain, gaining 35% in the last twelve months. That'll make it easier to manage its debt. 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 China Merchants Expressway Network & Technology HoldingsLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Happily for any shareholders, China Merchants Expressway Network & Technology HoldingsLtd 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

The good news is that China Merchants Expressway Network & Technology HoldingsLtd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its net debt to EBITDA has the opposite effect. It's also worth noting that China Merchants Expressway Network & Technology HoldingsLtd is in the Infrastructure industry, which is often considered to be quite defensive. Taking all this data into account, it seems to us that China Merchants Expressway Network & Technology HoldingsLtd takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that China Merchants Expressway Network & Technology HoldingsLtd is showing 3 warning signs in our investment analysis , and 1 of those is a bit concerning...

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.

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