These 4 Measures Indicate That Anhui Expressway (HKG:995) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Anhui Expressway

What Is Anhui Expressway's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Anhui Expressway had CN¥6.60b of debt in September 2023, down from CN¥7.17b, one year before. However, because it has a cash reserve of CN¥5.07b, its net debt is less, at about CN¥1.53b.

How Strong Is Anhui Expressway's Balance Sheet?

We can see from the most recent balance sheet that Anhui Expressway had liabilities of CN¥1.92b falling due within a year, and liabilities of CN¥6.22b due beyond that. Offsetting these obligations, it had cash of CN¥5.07b as well as receivables valued at CN¥274.3m due within 12 months. So its liabilities total CN¥2.79b more than the combination of its cash and short-term receivables.

Since publicly traded Anhui Expressway shares are worth a total of CN¥19.7b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Anhui Expressway has a low net debt to EBITDA ratio of only 0.47. And its EBIT easily covers its interest expense, being 43.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. And we also note warmly that Anhui Expressway grew its EBIT by 11% last year, making its debt load easier to handle. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Anhui Expressway recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

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. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Anhui Expressway's dividend history, without delay!

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.