These 4 Measures Indicate That Qilu Expressway (HKG:1576) Is Using Debt Reasonably Well

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 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. We can see that Qilu Expressway Company Limited (HKG:1576) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 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. 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.

View our latest analysis for Qilu Expressway

How Much Debt Does Qilu Expressway Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Qilu Expressway had debt of CN¥3.26b, up from CN¥1.97b in one year. However, it does have CN¥542.1m in cash offsetting this, leading to net debt of about CN¥2.71b.

How Healthy Is Qilu Expressway's Balance Sheet?

We can see from the most recent balance sheet that Qilu Expressway had liabilities of CN¥976.4m falling due within a year, and liabilities of CN¥2.83b due beyond that. Offsetting this, it had CN¥542.1m in cash and CN¥86.0m in receivables that were due within 12 months. So its liabilities total CN¥3.18b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥3.88b, so it does suggest shareholders should keep an eye on Qilu Expressway's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

With a debt to EBITDA ratio of 2.1, Qilu Expressway uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 9.7 times its interest expenses harmonizes with that theme. We saw Qilu Expressway grow its EBIT by 3.1% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Qilu Expressway's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Qilu Expressway actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On our analysis Qilu Expressway'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 example, its level of total liabilities makes us a little nervous about its debt. We would also note that Infrastructure industry companies like Qilu Expressway commonly do use debt without problems. Considering this range of data points, we think Qilu Expressway is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. For example - Qilu Expressway has 2 warning signs we think you should be aware of.

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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