Is Guangshen Railway (HKG:525) 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. Importantly, Guangshen Railway Company Limited (HKG:525) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Guangshen Railway

What Is Guangshen Railway's Debt?

As you can see below, at the end of December 2023, Guangshen Railway had CN¥1.56b of debt, up from CN¥1.50b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥1.48b, its net debt is less, at about CN¥74.0m.

A Look At Guangshen Railway's Liabilities

According to the last reported balance sheet, Guangshen Railway had liabilities of CN¥8.02b due within 12 months, and liabilities of CN¥2.86b due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.48b as well as receivables valued at CN¥6.87b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.53b.

Since publicly traded Guangshen Railway shares are worth a total of CN¥20.1b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, Guangshen Railway has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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.

Guangshen Railway has barely any net debt, as demonstrated by its net debt to EBITDA ratio of only 0.022. Humorously, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt as easily as enthusiastic spray-tanners take on an orange hue. It was also good to see that despite losing money on the EBIT line last year, Guangshen Railway turned things around in the last 12 months, delivering and EBIT of CN¥1.5b. 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 Guangshen Railway 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 is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. In the last year, Guangshen Railway created free cash flow amounting to 6.2% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Guangshen Railway's interest cover was a real positive on this analysis, as was its net debt to EBITDA. Having said that, its conversion of EBIT to free cash flow somewhat sensitizes us to potential future risks to the balance sheet. Considering this range of data points, we think Guangshen Railway 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. 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. We've identified 1 warning sign with Guangshen Railway , and understanding them should be part of your investment process.

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.