Is Anhui Expressway (HKG:995) A Risky Investment?

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.' 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 Anhui Expressway Company Limited (HKG:995) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

See 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 Anhui Expressway had debt of CN¥6.61b at the end of June 2023, a reduction from CN¥6.99b over a year. However, because it has a cash reserve of CN¥5.25b, its net debt is less, at about CN¥1.36b.

A Look At Anhui Expressway's Liabilities

The latest balance sheet data shows that Anhui Expressway had liabilities of CN¥2.40b due within a year, and liabilities of CN¥6.24b falling due after that. Offsetting this, it had CN¥5.25b in cash and CN¥263.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.12b.

Of course, Anhui Expressway has a market capitalization of CN¥16.8b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Anhui Expressway's net debt is only 0.41 times its EBITDA. And its EBIT covers its interest expense a whopping 28.5 times over. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Anhui Expressway grew its EBIT by 15% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Anhui Expressway's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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, Anhui Expressway produced sturdy free cash flow equating to 66% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Anhui Expressway's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. We would also note that Infrastructure industry companies like Anhui Expressway commonly do use debt without problems. Looking at the bigger picture, we think Anhui Expressway's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. Given Anhui Expressway has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.