Huayu Expressway Group (HKG:1823) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Huayu Expressway Group Limited (HKG:1823) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Huayu Expressway Group

What Is Huayu Expressway Group's Debt?

The image below, which you can click on for greater detail, shows that Huayu Expressway Group had debt of CN¥141.1m at the end of December 2022, a reduction from CN¥1.07b over a year. But it also has CN¥205.7m in cash to offset that, meaning it has CN¥64.6m net cash.

How Strong Is Huayu Expressway Group's Balance Sheet?

We can see from the most recent balance sheet that Huayu Expressway Group had liabilities of CN¥1.15b falling due within a year, and liabilities of CN¥263.0k due beyond that. Offsetting these obligations, it had cash of CN¥205.7m as well as receivables valued at CN¥28.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥918.5m.

This deficit casts a shadow over the CN¥568.9m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Huayu Expressway Group would probably need a major re-capitalization if its creditors were to demand repayment. Huayu Expressway Group boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

The modesty of its debt load may become crucial for Huayu Expressway Group if management cannot prevent a repeat of the 69% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Huayu Expressway Group 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Huayu Expressway Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Huayu Expressway Group 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.

Summing Up

Although Huayu Expressway Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥64.6m. And it impressed us with free cash flow of CN¥131m, being 100% of its EBIT. Despite its cash we think that Huayu Expressway Group seems to struggle to handle its total liabilities, so we are wary of the stock. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Huayu Expressway Group you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.