Anhui Expressway (HKG:995) Seems To Use Debt Rather Sparingly

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. As with many other companies Anhui Expressway Company Limited (HKG:995) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Anhui Expressway

What Is Anhui Expressway's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Anhui Expressway had debt of CN¥3.78b, up from CN¥2.89b in one year. However, its balance sheet shows it holds CN¥5.23b in cash, so it actually has CN¥1.45b net cash.

How Healthy Is Anhui Expressway's Balance Sheet?

According to the last reported balance sheet, Anhui Expressway had liabilities of CN¥1.44b due within 12 months, and liabilities of CN¥3.65b due beyond 12 months. Offsetting these obligations, it had cash of CN¥5.23b as well as receivables valued at CN¥199.7m due within 12 months. So it can boast CN¥339.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Anhui Expressway could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Anhui Expressway boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Anhui Expressway grew its EBIT by 107% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Anhui 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. Anhui Expressway may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Anhui Expressway produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Anhui Expressway has net cash of CN¥1.45b, as well as more liquid assets than liabilities. And we liked the look of last year's 107% year-on-year EBIT growth. So is Anhui Expressway's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Anhui Expressway you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.