Is China Merchants Port Holdings (HKG:144) Using Too Much Debt?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that China Merchants Port Holdings Company Limited (HKG:144) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

We've discovered 2 warning signs about China Merchants Port Holdings. View them for free.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does China Merchants Port Holdings Carry?

The image below, which you can click on for greater detail, shows that China Merchants Port Holdings had debt of HK$32.9b at the end of December 2024, a reduction from HK$36.3b over a year. However, it does have HK$11.4b in cash offsetting this, leading to net debt of about HK$21.5b.

How Strong Is China Merchants Port Holdings' Balance Sheet?

The latest balance sheet data shows that China Merchants Port Holdings had liabilities of HK$24.1b due within a year, and liabilities of HK$24.0b falling due after that. Offsetting these obligations, it had cash of HK$11.4b as well as receivables valued at HK$2.19b due within 12 months. So its liabilities total HK$34.4b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since China Merchants Port Holdings has a market capitalization of HK$59.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

See our latest analysis for China Merchants Port Holdings

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

China Merchants Port Holdings's debt is 3.8 times its EBITDA, and its EBIT cover its interest expense 3.3 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Fortunately, China Merchants Port Holdings grew its EBIT by 7.9% in the last year, slowly shrinking its debt relative to earnings. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if China Merchants Port Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, China Merchants Port Holdings 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 our analysis China Merchants Port Holdings's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to cover its interest expense with its EBIT. We would also note that Infrastructure industry companies like China Merchants Port Holdings commonly do use debt without problems. Considering this range of data points, we think China Merchants Port Holdings is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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 China Merchants Port Holdings (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

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.