Does Shandong Hi-Speed Holdings Group (HKG:412) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We can see that Shandong Hi-Speed Holdings Group Limited (HKG:412) does use debt in its business. But the more important question is: how much risk is that debt creating?

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What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Shandong Hi-Speed Holdings Group Carry?

You can click the graphic below for the historical numbers, but it shows that Shandong Hi-Speed Holdings Group had HK$43.0b of debt in December 2024, down from HK$45.8b, one year before. However, because it has a cash reserve of HK$9.08b, its net debt is less, at about HK$34.0b.

How Strong Is Shandong Hi-Speed Holdings Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shandong Hi-Speed Holdings Group had liabilities of HK$20.6b due within 12 months and liabilities of HK$27.9b due beyond that. On the other hand, it had cash of HK$9.08b and HK$15.2b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$24.2b.

This is a mountain of leverage relative to its market capitalization of HK$34.3b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

View our latest analysis for Shandong Hi-Speed Holdings Group

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.

Weak interest cover of 1.1 times and a disturbingly high net debt to EBITDA ratio of 9.3 hit our confidence in Shandong Hi-Speed Holdings Group like a one-two punch to the gut. The debt burden here is substantial. On a lighter note, we note that Shandong Hi-Speed Holdings Group grew its EBIT by 20% in the last year. If it can maintain that kind of improvement, its debt load will begin to melt away like glaciers in a warming world. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shandong Hi-Speed Holdings Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Shandong Hi-Speed Holdings Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Shandong Hi-Speed Holdings Group's interest cover was a real negative on this analysis, as was its net debt to EBITDA. But like a ballerina ending on a perfect pirouette, it has not trouble converting EBIT to free cash flow. When we consider all the factors mentioned above, we do feel a bit cautious about Shandong Hi-Speed Holdings Group's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Shandong Hi-Speed Holdings Group (1 is concerning) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.