These 4 Measures Indicate That Shenzhen Expressway (HKG:548) Is Using Debt Extensively

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Shenzhen Expressway Corporation Limited (HKG:548) 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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shenzhen Expressway

What Is Shenzhen Expressway's Net Debt?

As you can see below, Shenzhen Expressway had CN¥31.5b of debt at June 2024, down from CN¥34.0b a year prior. However, because it has a cash reserve of CN¥2.92b, its net debt is less, at about CN¥28.6b.

A Look At Shenzhen Expressway's Liabilities

We can see from the most recent balance sheet that Shenzhen Expressway had liabilities of CN¥15.1b falling due within a year, and liabilities of CN¥23.5b due beyond that. Offsetting this, it had CN¥2.92b in cash and CN¥2.63b in receivables that were due within 12 months. So it has liabilities totalling CN¥33.1b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥18.0b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Shenzhen Expressway would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Strangely Shenzhen Expressway has a sky high EBITDA ratio of 6.2, implying high debt, but a strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! Importantly Shenzhen Expressway's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Shenzhen 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Shenzhen Expressway produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On the face of it, Shenzhen Expressway's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. It's also worth noting that Shenzhen Expressway is in the Infrastructure industry, which is often considered to be quite defensive. Once we consider all the factors above, together, it seems to us that Shenzhen Expressway's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Shenzhen Expressway is showing 2 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.