Is Qingdao Port International (HKG:6198) Using Too Much 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.' 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 Qingdao Port International Co., Ltd. (HKG:6198) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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, 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.

Check out our latest analysis for Qingdao Port International

What Is Qingdao Port International's Net Debt?

The image below, which you can click on for greater detail, shows that Qingdao Port International had debt of CN¥1.17b at the end of June 2021, a reduction from CN¥2.67b over a year. But it also has CN¥9.65b in cash to offset that, meaning it has CN¥8.48b net cash.

How Healthy Is Qingdao Port International's Balance Sheet?

We can see from the most recent balance sheet that Qingdao Port International had liabilities of CN¥14.3b falling due within a year, and liabilities of CN¥5.40b due beyond that. Offsetting these obligations, it had cash of CN¥9.65b as well as receivables valued at CN¥6.85b due within 12 months. So it has liabilities totalling CN¥3.22b more than its cash and near-term receivables, combined.

Given Qingdao Port International has a market capitalization of CN¥35.0b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Qingdao Port International also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Qingdao Port International has been able to increase its EBIT by 20% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Qingdao Port International can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Qingdao Port International 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, Qingdao Port International created free cash flow amounting to 6.9% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Qingdao Port International has CN¥8.48b in net cash. And it impressed us with its EBIT growth of 20% over the last year. So we are not troubled with Qingdao Port International's debt use. 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. Case in point: We've spotted 1 warning sign for Qingdao Port International you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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