We Think Qinhuangdao Port (HKG:3369) Can Stay On Top Of Its Debt

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.' 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 Qinhuangdao Port Co., Ltd. (HKG:3369) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Qinhuangdao Port

What Is Qinhuangdao Port's Net Debt?

The chart below, which you can click on for greater detail, shows that Qinhuangdao Port had CN¥6.83b in debt in December 2020; about the same as the year before. On the flip side, it has CN¥3.55b in cash leading to net debt of about CN¥3.27b.

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¥3.40b due within 12 months and liabilities of CN¥6.75b due beyond that. Offsetting these obligations, it had cash of CN¥3.55b as well as receivables valued at CN¥270.4m due within 12 months. So it has liabilities totalling CN¥6.32b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Qinhuangdao Port has a market capitalization of CN¥10.6b, 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 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Qinhuangdao Port has a low net debt to EBITDA ratio of only 1.2. And its EBIT easily covers its interest expense, being 24.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the bad news is that Qinhuangdao Port has seen its EBIT plunge 12% in the last twelve months. 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 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Qinhuangdao Port recorded free cash flow worth a fulsome 99% 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

Qinhuangdao Port's interest cover was a real positive on this analysis, as was its conversion of EBIT to free cash flow. On the other hand, its EBIT growth rate makes us a little less comfortable about its debt. It's also worth noting that Qinhuangdao Port is in the Infrastructure industry, which is often considered to be quite defensive. When we consider all the elements mentioned above, it seems to us that Qinhuangdao Port is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Be aware that Qinhuangdao Port is showing 2 warning signs in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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