We Think Zhejiang Expressway (HKG:576) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Zhejiang Expressway Co., Ltd. (HKG:576) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Zhejiang Expressway

What Is Zhejiang Expressway's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Zhejiang Expressway had CN¥40.5b of debt, an increase on CN¥36.0b, over one year. But on the other hand it also has CN¥68.2b in cash, leading to a CN¥27.7b net cash position.

How Healthy Is Zhejiang Expressway's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Expressway had liabilities of CN¥108.9b falling due within a year, and liabilities of CN¥40.5b due beyond that. Offsetting these obligations, it had cash of CN¥68.2b as well as receivables valued at CN¥24.3b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥56.8b.

This deficit casts a shadow over the CN¥26.4b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Zhejiang Expressway would likely require a major re-capitalisation if it had to pay its creditors today. Given that Zhejiang Expressway has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Unfortunately, Zhejiang Expressway's EBIT flopped 14% over the last four quarters. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Zhejiang 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Zhejiang Expressway has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Zhejiang Expressway's free cash flow amounted to 21% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While Zhejiang Expressway does have more liabilities than liquid assets, it also has net cash of CN¥27.7b. Despite its cash we think that Zhejiang Expressway seems to struggle to handle its total liabilities, so we are wary of the stock. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Zhejiang Expressway (of which 1 is a bit concerning!) 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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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.