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

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Anhui Expressway Company Limited (HKG:995) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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

How Much Debt Does Anhui Expressway Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Anhui Expressway had debt of CN¥6.98b, up from CN¥6.61b in one year. However, it also had CN¥5.37b in cash, and so its net debt is CN¥1.61b.

How Strong Is Anhui Expressway's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Anhui Expressway had liabilities of CN¥2.99b due within 12 months and liabilities of CN¥6.43b due beyond that. Offsetting these obligations, it had cash of CN¥5.37b as well as receivables valued at CN¥139.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.91b.

Of course, Anhui Expressway has a market capitalization of CN¥20.7b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Anhui Expressway has a low net debt to EBITDA ratio of only 0.51. And its EBIT easily covers its interest expense, being 60.3 times the size. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Anhui Expressway saw its EBIT drop by 4.5% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Anhui Expressway recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Anhui Expressway's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its EBIT growth rate does undermine this impression a bit. It's also worth noting that Anhui Expressway is in the Infrastructure industry, which is often considered to be quite defensive. Looking at all the aforementioned factors together, it strikes us that Anhui Expressway can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Anhui Expressway is showing 2 warning signs in our investment analysis , you should know about...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.