COSCO SHIPPING Ports (HKG:1199) Has A Somewhat Strained Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that COSCO SHIPPING Ports Limited (HKG:1199) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for COSCO SHIPPING Ports

What Is COSCO SHIPPING Ports's Net Debt?

As you can see below, COSCO SHIPPING Ports had US$3.10b of debt, at June 2023, which is about the same as the year before. You can click the chart for greater detail. However, it also had US$928.3m in cash, and so its net debt is US$2.17b.

A Look At COSCO SHIPPING Ports' Liabilities

Zooming in on the latest balance sheet data, we can see that COSCO SHIPPING Ports had liabilities of US$1.34b due within 12 months and liabilities of US$3.47b due beyond that. Offsetting these obligations, it had cash of US$928.3m as well as receivables valued at US$257.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.62b.

This deficit casts a shadow over the US$2.01b 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, COSCO SHIPPING Ports 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).

While COSCO SHIPPING Ports's debt to EBITDA ratio (4.9) suggests that it uses some debt, its interest cover is very weak, at 2.1, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Given the debt load, it's hardly ideal that COSCO SHIPPING Ports's EBIT was pretty flat over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if COSCO SHIPPING Ports 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, COSCO SHIPPING Ports produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On the face of it, COSCO SHIPPING Ports's interest cover 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 COSCO SHIPPING Ports is in the Infrastructure industry, which is often considered to be quite defensive. Overall, it seems to us that COSCO SHIPPING Ports's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with COSCO SHIPPING Ports .

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.