Yuexiu Transport Infrastructure (HKG:1052) Use Of Debt Could Be Considered Risky

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Yuexiu Transport Infrastructure Limited (HKG:1052) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See 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¥17.7b in debt in December 2020; about the same as the year before. On the flip side, it has CN¥1.52b in cash leading to net debt of about CN¥16.2b.

A Look At Yuexiu Transport Infrastructure's Liabilities

Zooming in on the latest balance sheet data, we can see that Yuexiu Transport Infrastructure had liabilities of CN¥4.23b due within 12 months and liabilities of CN¥18.5b due beyond that. On the other hand, it had cash of CN¥1.52b and CN¥362.0m worth of receivables due within a year. So its liabilities total CN¥20.8b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥6.90b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Yuexiu Transport Infrastructure would probably need a major re-capitalization if its creditors were to demand repayment.

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.

Weak interest cover of 1.7 times and a disturbingly high net debt to EBITDA ratio of 7.1 hit our confidence in Yuexiu Transport Infrastructure like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Yuexiu Transport Infrastructure saw its EBIT tank 26% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Yuexiu Transport Infrastructure 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Yuexiu Transport Infrastructure actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

On the face of it, Yuexiu Transport Infrastructure's EBIT growth rate 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 at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. It's also worth noting that Yuexiu Transport Infrastructure is in the Infrastructure industry, which is often considered to be quite defensive. We're quite clear that we consider Yuexiu Transport Infrastructure to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Yuexiu Transport Infrastructure is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

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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