Is Qinhuangdao Port (HKG:3369) A Risky Investment?

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.' 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 can see that Qinhuangdao Port Co., Ltd. (HKG:3369) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Qinhuangdao Port

What Is Qinhuangdao Port's Debt?

The chart below, which you can click on for greater detail, shows that Qinhuangdao Port had CN¥7.03b in debt in March 2021; about the same as the year before. However, because it has a cash reserve of CN¥4.07b, its net debt is less, at about CN¥2.96b.

How Strong Is Qinhuangdao Port's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Qinhuangdao Port had liabilities of CN¥3.53b due within 12 months and liabilities of CN¥6.78b due beyond that. On the other hand, it had cash of CN¥4.07b and CN¥260.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.98b.

While this might seem like a lot, it is not so bad since Qinhuangdao Port has a market capitalization of CN¥10.2b, 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.

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.

Qinhuangdao Port's net debt is only 1.0 times its EBITDA. And its EBIT covers its interest expense a whopping 34.2 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Qinhuangdao Port's EBIT dived 12%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Qinhuangdao Port will need earnings to service that debt. 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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Qinhuangdao Port generated free cash flow amounting to a very robust 94% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Both Qinhuangdao Port's ability to to cover its interest expense with its EBIT and its conversion of EBIT to free cash flow gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to grow its EBIT. We would also note that Infrastructure industry companies like Qinhuangdao Port commonly do use debt without problems. When we consider all the elements mentioned above, it seems to us that Qinhuangdao Port is managing its debt quite well. 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. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Qinhuangdao Port you should be aware of.

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.
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