These 4 Measures Indicate That China State Construction Engineering (SHSE:601668) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 China State Construction Engineering Corporation Limited (SHSE:601668) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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 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. 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 State Construction Engineering

How Much Debt Does China State Construction Engineering Carry?

The image below, which you can click on for greater detail, shows that at September 2024 China State Construction Engineering had debt of CN¥880.6b, up from CN¥769.2b in one year. However, it also had CN¥321.1b in cash, and so its net debt is CN¥559.5b.

How Healthy Is China State Construction Engineering's Balance Sheet?

The latest balance sheet data shows that China State Construction Engineering had liabilities of CN¥1.83t due within a year, and liabilities of CN¥659.9b falling due after that. On the other hand, it had cash of CN¥321.1b and CN¥946.2b worth of receivables due within a year. So it has liabilities totalling CN¥1.23t more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥233.0b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, China State Construction Engineering would probably need a major re-capitalization if its creditors were to demand repayment.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt to EBITDA of 4.7 China State Construction Engineering has a fairly noticeable amount of debt. On the plus side, its EBIT was 7.5 times its interest expense, and its net debt to EBITDA, was quite high, at 4.7. We saw China State Construction Engineering grow its EBIT by 4.7% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine China State Construction Engineering's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, China State Construction Engineering 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

To be frank both China State Construction Engineering's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Overall, it seems to us that China State Construction Engineering's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with China State Construction Engineering (including 1 which shouldn't be ignored) .

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.