These 4 Measures Indicate That Sichuan Expressway (HKG:107) Is Using Debt Extensively

Warren Buffett famously said, '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. Importantly, Sichuan Expressway Company Limited (HKG:107) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 Sichuan Expressway

How Much Debt Does Sichuan Expressway Carry?

The image below, which you can click on for greater detail, shows that at June 2021 Sichuan Expressway had debt of CN¥19.3b, up from CN¥17.6b in one year. However, it does have CN¥3.43b in cash offsetting this, leading to net debt of about CN¥15.9b.

A Look At Sichuan Expressway's Liabilities

We can see from the most recent balance sheet that Sichuan Expressway had liabilities of CN¥5.32b falling due within a year, and liabilities of CN¥18.9b due beyond that. On the other hand, it had cash of CN¥3.43b and CN¥596.8m worth of receivables due within a year. So its liabilities total CN¥20.2b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥8.73b 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, Sichuan Expressway 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt to EBITDA of 4.7 Sichuan Expressway has a fairly noticeable amount of debt. But the high interest coverage of 9.6 suggests it can easily service that debt. Notably, Sichuan Expressway's EBIT launched higher than Elon Musk, gaining a whopping 175% on last year. 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 Sichuan Expressway'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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Sichuan Expressway created free cash flow amounting to 5.4% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

We'd go so far as to say Sichuan Expressway's level of total liabilities was disappointing. But at least it's pretty decent at growing its EBIT; that's encouraging. It's also worth noting that Sichuan Expressway is in the Infrastructure industry, which is often considered to be quite defensive. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Sichuan Expressway stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Sichuan Expressway (of which 2 are a bit unpleasant!) 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.
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