These 4 Measures Indicate That Yuexiu Transport Infrastructure (HKG:1052) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Yuexiu Transport Infrastructure Limited (HKG:1052) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 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. 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.

Check out our latest analysis for Yuexiu Transport Infrastructure

What Is Yuexiu Transport Infrastructure's Net Debt?

The chart below, which you can click on for greater detail, shows that Yuexiu Transport Infrastructure had CN¥16.7b in debt in June 2023; about the same as the year before. However, it does have CN¥1.77b in cash offsetting this, leading to net debt of about CN¥14.9b.

A Look At Yuexiu Transport Infrastructure's Liabilities

We can see from the most recent balance sheet that Yuexiu Transport Infrastructure had liabilities of CN¥8.49b falling due within a year, and liabilities of CN¥12.5b due beyond that. Offsetting these obligations, it had cash of CN¥1.77b as well as receivables valued at CN¥309.5m due within 12 months. So it has liabilities totalling CN¥18.9b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥6.39b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Yuexiu Transport Infrastructure would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

With a net debt to EBITDA ratio of 5.3, it's fair to say Yuexiu Transport Infrastructure does have a significant amount of debt. However, its interest coverage of 3.1 is reasonably strong, which is a good sign. Given the debt load, it's hardly ideal that Yuexiu Transport Infrastructure's EBIT was pretty flat over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Yuexiu Transport Infrastructure'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. Over the last three years, Yuexiu Transport Infrastructure 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

On the face of it, Yuexiu Transport Infrastructure's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. We should also note that Infrastructure industry companies like Yuexiu Transport Infrastructure commonly do use debt without problems. Looking at the bigger picture, it seems clear to us that Yuexiu Transport Infrastructure's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Yuexiu Transport Infrastructure (1 is potentially serious) you should be aware of.

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.