Is Anhui Expressway (HKG:995) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Anhui Expressway Company Limited (HKG:995) does use debt in its business. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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.

Check out our latest analysis for Anhui Expressway

What Is Anhui Expressway's Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Anhui Expressway had debt of CN¥3.61b, up from CN¥2.99b in one year. But it also has CN¥4.91b in cash to offset that, meaning it has CN¥1.30b net cash.

A Look At Anhui Expressway's Liabilities

We can see from the most recent balance sheet that Anhui Expressway had liabilities of CN¥1.87b falling due within a year, and liabilities of CN¥3.46b due beyond that. Offsetting these obligations, it had cash of CN¥4.91b as well as receivables valued at CN¥216.0m due within 12 months. So its liabilities total CN¥204.9m more than the combination of its cash and short-term receivables.

Given Anhui Expressway has a market capitalization of CN¥10.0b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Anhui Expressway also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Anhui Expressway grew its EBIT by 134% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. 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 company can only pay off debt with cold hard cash, not accounting profits. While Anhui 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. During the last three years, Anhui Expressway produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Anhui Expressway has CN¥1.30b in net cash. And we liked the look of last year's 134% year-on-year EBIT growth. So is Anhui Expressway's debt a risk? It doesn't seem so to us. 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.
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