China Merchants Expressway Network & Technology HoldingsLtd (SZSE:001965) Has A Pretty 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.' 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 China Merchants Expressway Network & Technology Holdings Co.,Ltd. (SZSE:001965) makes use of debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Debt?

The image below, which you can click on for greater detail, shows that at June 2024 China Merchants Expressway Network & Technology HoldingsLtd had debt of CN¥59.1b, up from CN¥39.2b in one year. On the flip side, it has CN¥8.44b in cash leading to net debt of about CN¥50.7b.

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

Zooming in on the latest balance sheet data, we can see that China Merchants Expressway Network & Technology HoldingsLtd had liabilities of CN¥17.1b due within 12 months and liabilities of CN¥59.0b due beyond that. Offsetting these obligations, it had cash of CN¥8.44b as well as receivables valued at CN¥6.31b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥61.3b.

This deficit is considerable relative to its very significant market capitalization of CN¥82.0b, so it does suggest shareholders should keep an eye on China Merchants Expressway Network & Technology HoldingsLtd's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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).

As it happens China Merchants Expressway Network & Technology HoldingsLtd has a fairly concerning net debt to EBITDA ratio of 8.1 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! Importantly, China Merchants Expressway Network & Technology HoldingsLtd grew its EBIT by 33% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, China Merchants Expressway Network & Technology HoldingsLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Happily, China Merchants Expressway Network & Technology HoldingsLtd's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its net debt to EBITDA. We would also note that Infrastructure industry companies like China Merchants Expressway Network & Technology HoldingsLtd commonly do use debt without problems. Taking all this data into account, it seems to us that China Merchants Expressway Network & Technology HoldingsLtd takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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 3 warning signs for China Merchants Expressway Network & Technology HoldingsLtd you should be aware of, and 1 of them is 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.