Is COSCO SHIPPING Ports (HKG:1199) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that COSCO SHIPPING Ports Limited (HKG:1199) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for COSCO SHIPPING Ports

How Much Debt Does COSCO SHIPPING Ports Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 COSCO SHIPPING Ports had US$2.97b of debt, an increase on US$2.83b, over one year. On the flip side, it has US$1.04b in cash leading to net debt of about US$1.93b.

How Strong Is COSCO SHIPPING Ports' Balance Sheet?

According to the last reported balance sheet, COSCO SHIPPING Ports had liabilities of US$1.06b due within 12 months, and liabilities of US$3.66b due beyond 12 months. Offsetting these obligations, it had cash of US$1.04b as well as receivables valued at US$294.2m due within 12 months. So its liabilities total US$3.39b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's US$2.73b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

COSCO SHIPPING Ports shareholders face the double whammy of a high net debt to EBITDA ratio (7.0), and fairly weak interest coverage, since EBIT is just 1.2 times the interest expense. The debt burden here is substantial. Even worse, COSCO SHIPPING Ports saw its EBIT tank 46% 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. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, COSCO SHIPPING Ports produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

To be frank both COSCO SHIPPING Ports's interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least its conversion of EBIT to free cash flow is not so bad. It's also worth noting that COSCO SHIPPING Ports is in the Infrastructure industry, which is often considered to be quite defensive. Taking into account all the aforementioned factors, it looks like COSCO SHIPPING Ports has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for COSCO SHIPPING Ports that you should be aware of before investing here.

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.