Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Liaoning Port Co., Ltd. (HKG:2880) does carry debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

What Is Liaoning Port's Net Debt?

As you can see below, Liaoning Port had CN¥5.91b of debt at September 2023, down from CN¥7.73b a year prior. On the flip side, it has CN¥4.35b in cash leading to net debt of about CN¥1.56b.

How Strong Is Liaoning Port's Balance Sheet?

We can see from the most recent balance sheet that Liaoning Port had liabilities of CN¥4.92b falling due within a year, and liabilities of CN¥8.65b due beyond that. Offsetting these obligations, it had cash of CN¥4.35b as well as receivables valued at CN¥4.63b due within 12 months. So it has liabilities totalling CN¥4.59b more than its cash and near-term receivables, combined.

Of course, Liaoning Port has a market capitalization of CN¥30.6b, 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.

Looking at its net debt to EBITDA of 0.35 and interest cover of 6.5 times, it seems to us that Liaoning Port is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. While Liaoning Port doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Liaoning Port's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Liaoning Port recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

When it comes to the balance sheet, the standout positive for Liaoning Port was the fact that it seems able handle its debt, based on its EBITDA, confidently. However, our other observations weren't so heartening. For example, its conversion of EBIT to free cash flow makes us a little nervous about its debt. We would also note that Infrastructure industry companies like Liaoning Port commonly do use debt without problems. When we consider all the elements mentioned above, it seems to us that Liaoning Port is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. Given Liaoning Port has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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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