Does Qilu Expressway (HKG:1576) Have A Healthy 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Qilu Expressway Company Limited (HKG:1576) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Our analysis indicates that 1576 is potentially undervalued!

What Is Qilu Expressway's Net Debt?

The chart below, which you can click on for greater detail, shows that Qilu Expressway had CN¥2.70b in debt in June 2022; about the same as the year before. However, it does have CN¥1.99b in cash offsetting this, leading to net debt of about CN¥715.2m.

How Healthy Is Qilu Expressway's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Qilu Expressway had liabilities of CN¥1.21b due within 12 months and liabilities of CN¥2.50b due beyond that. On the other hand, it had cash of CN¥1.99b and CN¥199.8m worth of receivables due within a year. So its liabilities total CN¥1.51b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Qilu Expressway has a market capitalization of CN¥3.87b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Qilu Expressway's net debt is only 0.47 times its EBITDA. And its EBIT easily covers its interest expense, being 12.4 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that Qilu Expressway saw its EBIT decline by 9.8% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is Qilu Expressway's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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, Qilu Expressway recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Qilu Expressway's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its EBIT growth rate. It's also worth noting that Qilu Expressway is in the Infrastructure industry, which is often considered to be quite defensive. Taking all this data into account, it seems to us that Qilu Expressway takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. For example, we've discovered 1 warning sign for Qilu Expressway that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.