Here's Why China National Chemical Engineering (SHSE:601117) Can Manage Its Debt Responsibly

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. We note that China National Chemical Engineering Co., Ltd (SHSE:601117) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for China National Chemical Engineering

What Is China National Chemical Engineering's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 China National Chemical Engineering had CN¥12.2b of debt, an increase on CN¥8.32b, over one year. But it also has CN¥36.8b in cash to offset that, meaning it has CN¥24.7b net cash.

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

Zooming in on the latest balance sheet data, we can see that China National Chemical Engineering had liabilities of CN¥137.2b due within 12 months and liabilities of CN¥13.1b due beyond that. Offsetting these obligations, it had cash of CN¥36.8b as well as receivables valued at CN¥94.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥18.9b.

While this might seem like a lot, it is not so bad since China National Chemical Engineering has a market capitalization of CN¥41.5b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. 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.

And we also note warmly that China National Chemical Engineering grew its EBIT by 19% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine China National Chemical Engineering's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While China National Chemical Engineering has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Considering the last three years, China National Chemical Engineering actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

Although China National Chemical Engineering's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥24.7b. And it impressed us with its EBIT growth of 19% over the last year. So we are not troubled with China National Chemical Engineering's debt use. There's no doubt that we learn most about debt from the balance sheet. 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.

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.