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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies China National Chemical Engineering Co., Ltd (SHSE:601117) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its 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 China National Chemical Engineering had CN¥8.40b of debt in June 2024, down from CN¥11.6b, one year before. But it also has CN¥43.0b in cash to offset that, meaning it has CN¥34.6b 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¥146.4b due within 12 months and liabilities of CN¥9.74b due beyond that. On the other hand, it had cash of CN¥43.0b and CN¥104.0b worth of receivables due within a year. So it has liabilities totalling CN¥9.16b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since China National Chemical Engineering has a market capitalization of CN¥42.0b, 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. 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!

Also good is that China National Chemical Engineering grew its EBIT at 15% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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

While China National Chemical Engineering does have more liabilities than liquid assets, it also has net cash of CN¥34.6b. And we liked the look of last year's 15% year-on-year EBIT growth. So we don't have any problem with China National Chemical Engineering's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for China National Chemical Engineering you should be aware of.

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.