Warren Buffett famously said, '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. We can see that China Merchants Expressway Network & Technology Holdings Co.,Ltd. (SZSE:001965) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is China Merchants Expressway Network & Technology HoldingsLtd's Debt?

As you can see below, China Merchants Expressway Network & Technology HoldingsLtd had CN¥39.7b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of CN¥7.14b, its net debt is less, at about CN¥32.6b.

A Look At China Merchants Expressway Network & Technology HoldingsLtd's Liabilities

We can see from the most recent balance sheet that China Merchants Expressway Network & Technology HoldingsLtd had liabilities of CN¥13.6b falling due within a year, and liabilities of CN¥35.7b due beyond that. On the other hand, it had cash of CN¥7.14b and CN¥4.54b worth of receivables due within a year. So its liabilities total CN¥37.7b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because China Merchants Expressway Network & Technology HoldingsLtd is worth CN¥63.7b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

As it happens China Merchants Expressway Network & Technology HoldingsLtd has a fairly concerning net debt to EBITDA ratio of 8.0 but very strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! If China Merchants Expressway Network & Technology HoldingsLtd can keep growing EBIT at last year's rate of 17% over the last year, then it will find its debt load easier to manage. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if China Merchants Expressway Network & Technology HoldingsLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, China Merchants Expressway Network & Technology HoldingsLtd actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

The good news is that China Merchants Expressway Network & Technology HoldingsLtd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its net debt to EBITDA. It's also worth noting that China Merchants Expressway Network & Technology HoldingsLtd is in the Infrastructure industry, which is often considered to be quite defensive. All these things considered, it appears that China Merchants Expressway Network & Technology HoldingsLtd can comfortably handle its current debt levels. 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. For instance, we've identified 2 warning signs for China Merchants Expressway Network & Technology HoldingsLtd (1 is concerning) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.