Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Guangdong Provincial Expressway Development Co., Ltd. (SZSE:200429) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Guangdong Provincial Expressway Development

How Much Debt Does Guangdong Provincial Expressway Development Carry?

The image below, which you can click on for greater detail, shows that Guangdong Provincial Expressway Development had debt of CN¥6.72b at the end of June 2022, a reduction from CN¥7.65b over a year. However, it does have CN¥4.05b in cash offsetting this, leading to net debt of about CN¥2.67b.

A Look At Guangdong Provincial Expressway Development's Liabilities

According to the last reported balance sheet, Guangdong Provincial Expressway Development had liabilities of CN¥2.54b due within 12 months, and liabilities of CN¥6.32b due beyond 12 months. Offsetting this, it had CN¥4.05b in cash and CN¥134.6m in receivables that were due within 12 months. So it has liabilities totalling CN¥4.67b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Guangdong Provincial Expressway Development is worth CN¥14.2b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Guangdong Provincial Expressway Development has a low debt to EBITDA ratio of only 0.68. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. But the other side of the story is that Guangdong Provincial Expressway Development saw its EBIT decline by 9.2% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Guangdong Provincial Expressway Development's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Guangdong Provincial Expressway Development generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Guangdong Provincial Expressway Development's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its EBIT growth rate. It's also worth noting that Guangdong Provincial Expressway Development is in the Infrastructure industry, which is often considered to be quite defensive. Taking all this data into account, it seems to us that Guangdong Provincial Expressway Development 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. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Guangdong Provincial Expressway Development you should know about.

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.