We Think Anhui Expressway (HKG:995) Can Stay On Top Of Its Debt

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.' 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. As with many other companies Anhui Expressway Company Limited (HKG:995) makes use of debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Anhui Expressway

How Much Debt Does Anhui Expressway Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 Anhui Expressway had CN¥6.78b of debt, an increase on CN¥5.46b, over one year. However, it does have CN¥4.73b in cash offsetting this, leading to net debt of about CN¥2.04b.

How Strong Is Anhui Expressway's Balance Sheet?

The latest balance sheet data shows that Anhui Expressway had liabilities of CN¥1.38b due within a year, and liabilities of CN¥6.42b falling due after that. On the other hand, it had cash of CN¥4.73b and CN¥472.1m worth of receivables due within a year. So it has liabilities totalling CN¥2.60b more than its cash and near-term receivables, combined.

Of course, Anhui Expressway has a market capitalization of CN¥13.8b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Anhui Expressway's net debt is only 0.68 times its EBITDA. And its EBIT covers its interest expense a whopping 19.0 times over. So we're pretty relaxed about its super-conservative use of debt. But the other side of the story is that Anhui Expressway saw its EBIT decline by 5.5% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. 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.

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. Over the most recent three years, Anhui Expressway recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

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, on a more sombre note, we are a little concerned by its EBIT growth rate. We would also note that Infrastructure industry companies like Anhui Expressway commonly do use debt without problems. Taking all this data into account, it seems to us that Anhui Expressway takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Anhui Expressway , and understanding them should be part of your investment process.

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.