Here's Why China Merchants Expressway Network & Technology HoldingsLtd (SZSE:001965) Can Manage Its Debt Responsibly

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. 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?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

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

How Much Debt Does China Merchants Expressway Network & Technology HoldingsLtd Carry?

As you can see below, China Merchants Expressway Network & Technology HoldingsLtd had CN¥39.7b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CN¥7.14b in cash leading to net debt of about CN¥32.6b.

A Look At China Merchants Expressway Network & Technology HoldingsLtd's Liabilities

We can see from the most recent balance sheet that China Merchants Expressway Network & Technology HoldingsLtd had liabilities of CN¥13.6b falling due within a year, and liabilities of CN¥35.7b due beyond that. Offsetting these obligations, it had cash of CN¥7.14b as well as receivables valued at CN¥4.54b due within 12 months. So its liabilities total CN¥37.7b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because China Merchants Expressway Network & Technology HoldingsLtd is worth CN¥65.7b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Strangely China Merchants Expressway Network & Technology HoldingsLtd has a sky high EBITDA ratio of 8.0, implying high debt, but a strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. One way China Merchants Expressway Network & Technology HoldingsLtd could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 17%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine China Merchants Expressway Network & Technology HoldingsLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept 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. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

China Merchants Expressway Network & Technology HoldingsLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its net debt to EBITDA has the opposite effect. We would also note that Infrastructure industry companies like China Merchants Expressway Network & Technology HoldingsLtd commonly do use debt without problems. All these things considered, it appears that China Merchants Expressway Network & Technology HoldingsLtd can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for China Merchants Expressway Network & Technology HoldingsLtd you should be aware of, and 1 of them shouldn't be ignored.

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.