Does Zhejiang Expressway (HKG:576) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Zhejiang Expressway Co., Ltd. (HKG:576) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Zhejiang Expressway

What Is Zhejiang Expressway's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Zhejiang Expressway had CN¥32.4b of debt, an increase on CN¥26.1b, over one year. On the flip side, it has CN¥16.0b in cash leading to net debt of about CN¥16.4b.

A Look At Zhejiang Expressway's Liabilities

According to the last reported balance sheet, Zhejiang Expressway had liabilities of CN¥98.7b due within 12 months, and liabilities of CN¥32.4b due beyond 12 months. Offsetting this, it had CN¥16.0b in cash and CN¥24.2b in receivables that were due within 12 months. So it has liabilities totalling CN¥90.8b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥24.8b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Zhejiang Expressway would probably need a major re-capitalization if its creditors were to demand repayment.

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.

Zhejiang Expressway's net debt is sitting at a very reasonable 1.7 times its EBITDA, while its EBIT covered its interest expense just 4.8 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Pleasingly, Zhejiang Expressway is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 122% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Zhejiang Expressway's ability to maintain a healthy balance sheet going forward. 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 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. In the last three years, Zhejiang Expressway created free cash flow amounting to 10% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Mulling over Zhejiang Expressway's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We should also note that Infrastructure industry companies like Zhejiang Expressway commonly do use debt without problems. Once we consider all the factors above, together, it seems to us that Zhejiang 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. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Zhejiang Expressway (2 shouldn't be ignored!) that you should be aware of before investing here.

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.

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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