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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Asia-potash International Investment (Guangzhou)Co.,Ltd. (SZSE:000893) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Asia-potash International Investment (Guangzhou)Co.Ltd Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Asia-potash International Investment (Guangzhou)Co.Ltd had CN¥1.84b of debt, an increase on none, over one year. However, it also had CN¥564.4m in cash, and so its net debt is CN¥1.27b.

How Healthy Is Asia-potash International Investment (Guangzhou)Co.Ltd's Balance Sheet?

The latest balance sheet data shows that Asia-potash International Investment (Guangzhou)Co.Ltd had liabilities of CN¥2.08b due within a year, and liabilities of CN¥1.64b falling due after that. Offsetting this, it had CN¥564.4m in cash and CN¥127.3m in receivables that were due within 12 months. So its liabilities total CN¥3.04b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Asia-potash International Investment (Guangzhou)Co.Ltd is worth CN¥14.7b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Asia-potash International Investment (Guangzhou)Co.Ltd has a low net debt to EBITDA ratio of only 0.76. And its EBIT covers its interest expense a whopping 115 times over. So we're pretty relaxed about its super-conservative use of debt. In fact Asia-potash International Investment (Guangzhou)Co.Ltd's saving grace is its low debt levels, because its EBIT has tanked 48% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Asia-potash International Investment (Guangzhou)Co.Ltd 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Asia-potash International Investment (Guangzhou)Co.Ltd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Asia-potash International Investment (Guangzhou)Co.Ltd's EBIT growth rate and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But its interest cover tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Asia-potash International Investment (Guangzhou)Co.Ltd's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Asia-potash International Investment (Guangzhou)Co.Ltd has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com