We Think Jiangsu Expressway (HKG:177) Is Taking Some Risk With Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 note that Jiangsu Expressway Company Limited (HKG:177) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Jiangsu Expressway

What Is Jiangsu Expressway's Debt?

The image below, which you can click on for greater detail, shows that at March 2023 Jiangsu Expressway had debt of CN¥36.2b, up from CN¥28.1b in one year. However, it also had CN¥5.83b in cash, and so its net debt is CN¥30.4b.

A Look At Jiangsu Expressway's Liabilities

The latest balance sheet data shows that Jiangsu Expressway had liabilities of CN¥13.3b due within a year, and liabilities of CN¥27.4b falling due after that. Offsetting this, it had CN¥5.83b in cash and CN¥1.32b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥33.5b.

This is a mountain of leverage relative to its market capitalization of CN¥43.3b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Jiangsu Expressway has a debt to EBITDA ratio of 4.8, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 1k times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Unfortunately, Jiangsu Expressway saw its EBIT slide 4.1% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. 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 Jiangsu Expressway 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. In the last three years, Jiangsu Expressway's free cash flow amounted to 24% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Neither Jiangsu Expressway's ability handle its debt, based on its EBITDA, nor its level of total liabilities gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. It's also worth noting that Jiangsu Expressway is in the Infrastructure industry, which is often considered to be quite defensive. When we consider all the factors discussed, it seems to us that Jiangsu Expressway is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Be aware that Jiangsu Expressway is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.