Is Liaoning Port (HKG:2880) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Liaoning Port Co., Ltd. (HKG:2880) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Liaoning Port

What Is Liaoning Port's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2022 Liaoning Port had debt of CN¥7.73b, up from CN¥4.85b in one year. On the flip side, it has CN¥4.66b in cash leading to net debt of about CN¥3.07b.

A Look At Liaoning Port's Liabilities

Zooming in on the latest balance sheet data, we can see that Liaoning Port had liabilities of CN¥6.66b due within 12 months and liabilities of CN¥9.49b due beyond that. Offsetting these obligations, it had cash of CN¥4.66b as well as receivables valued at CN¥4.10b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥7.38b.

While this might seem like a lot, it is not so bad since Liaoning Port has a market capitalization of CN¥34.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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

Liaoning Port's net debt is only 0.71 times its EBITDA. And its EBIT easily covers its interest expense, being 17.0 times the size. So we're pretty relaxed about its super-conservative use of debt. In fact Liaoning Port's saving grace is its low debt levels, because its EBIT has tanked 29% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is Liaoning Port'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Liaoning Port recorded free cash flow of 41% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Liaoning Port's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. We would also note that Infrastructure industry companies like Liaoning Port commonly do use debt without problems. When we consider all the factors mentioned above, we do feel a bit cautious about Liaoning Port's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Liaoning Port that 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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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.