Yuexiu Transport Infrastructure (HKG: 1052) takes some risk with its use of debt
David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies Yuexiu transport infrastructure limited (HKG:1052) uses debt. But does this debt worry shareholders?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Yuexiu Transport Infrastructure
What is Yuexiu’s transport infrastructure debt?
The image below, which you can click for more details, shows that Yuexiu Transport Infrastructure had a debt of 16.7 billion yen at the end of December 2021, a reduction from 17.7 billion yen on a year. However, he also had 2.92 billion yen in cash, so his net debt is 13.8 billion yen.
How healthy is Yuexiu Transport Infrastructure’s balance sheet?
According to the latest published balance sheet, Yuexiu Transport Infrastructure had liabilities of 4.59 billion Canadian yen due within 12 months and liabilities of 16.6 billion domestic yen due beyond 12 months. In compensation for these obligations, it had cash of 2.92 billion yen as well as receivables valued at 374.4 million yen due within 12 months. It therefore has liabilities totaling 17.9 billion Canadian yen more than its cash and short-term receivables, combined.
The deficiency here weighs heavily on the CN¥6.26b business itself, like a child struggling under the weight of a huge backpack full of books, his sports gear and a trumpet. So we definitely think shareholders need to watch this one closely. Ultimately, Yuexiu Transport Infrastructure would likely need a major recapitalization if its creditors were to demand repayment.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Yuexiu Transport Infrastructure’s debt is 4.7 times its EBITDA, and its EBIT covers its interest expense 2.7 times. Taken together, this implies that, while we wouldn’t like to see debt levels increase, we think he can manage his current leverage. On the bright side, Yuexiu Transport Infrastructure increased its EBIT by 41% last year. Like a mother’s loving embrace of a newborn, this kind of growth builds resilience, putting the company in a stronger position to manage its debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Yuexiu Transport Infrastructure can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. It is therefore worth checking how much of this EBIT is supported by free cash flow. Fortunately for all shareholders, Yuexiu Transport Infrastructure has actually produced more free cash flow than EBIT over the past three years. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
We feel some trepidation about the difficulty level of Yuexiu Transport Infrastructure’s total passive, but we also have some positives to focus on. The EBIT to free cash flow conversion and the EBIT growth rate were encouraging signs. It should also be noted that companies in the infrastructure sector such as Yuexiu Transport Infrastructure generally use debt without problems. Looking at all the angles discussed above, it does seem to us that Yuexiu Transport Infrastructure is a somewhat risky investment due to its leverage. Not all risk is bad, as it can increase stock price returns if it pays off, but this leverage risk is worth keeping in mind. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Example: we have identified 4 warning signs for Yuexiu transportation infrastructure you should be aware of, and 2 of them should not be ignored.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.