China National Chemical Engineering (SHSE:601117) Has A Pretty Healthy Balance Sheet

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.' 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. We note that China National Chemical Engineering Co., Ltd (SHSE:601117) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for China National Chemical Engineering

What Is China National Chemical Engineering's Net Debt?

The image below, which you can click on for greater detail, shows that China National Chemical Engineering had debt of CN¥8.30b at the end of September 2024, a reduction from CN¥12.2b over a year. But it also has CN¥39.7b in cash to offset that, meaning it has CN¥31.4b net cash.

How Healthy Is China National Chemical Engineering's Balance Sheet?

The latest balance sheet data shows that China National Chemical Engineering had liabilities of CN¥147.3b due within a year, and liabilities of CN¥9.90b falling due after that. Offsetting these obligations, it had cash of CN¥39.7b as well as receivables valued at CN¥103.2b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥14.2b.

China National Chemical Engineering has a market capitalization of CN¥45.3b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, China National Chemical Engineering also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that China National Chemical Engineering has been able to increase its EBIT by 21% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if China National Chemical Engineering can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. China National Chemical Engineering may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, China National Chemical Engineering reported free cash flow worth 9.1% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While China National Chemical Engineering does have more liabilities than liquid assets, it also has net cash of CN¥31.4b. And it impressed us with its EBIT growth of 21% over the last year. So we don't have any problem with China National Chemical Engineering's use of debt. 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 - China National Chemical Engineering has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.