We Think China National Chemical Engineering (SHSE:601117) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 can see that China National Chemical Engineering Co., Ltd (SHSE:601117) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for China National Chemical Engineering

What Is China National Chemical Engineering's Debt?

You can click the graphic below for the historical numbers, but it shows that China National Chemical Engineering had CN¥9.15b of debt in March 2024, down from CN¥11.1b, one year before. But it also has CN¥41.0b in cash to offset that, meaning it has CN¥31.9b 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¥144.2b due within a year, and liabilities of CN¥9.71b falling due after that. On the other hand, it had cash of CN¥41.0b and CN¥97.1b worth of receivables due within a year. So it has liabilities totalling CN¥15.8b more than its cash and near-term receivables, combined.

China National Chemical Engineering has a market capitalization of CN¥49.0b, so it could very likely raise cash to ameliorate 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. Despite its noteworthy liabilities, China National Chemical Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that China National Chemical Engineering grew its EBIT by 14% last year, making its debt load easier to handle. 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'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. 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 recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

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¥31.9b. On top of that, it increased its EBIT by 14% in the last twelve months. 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.

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.

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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.

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