Is East China Engineering Science and Technology (SZSE:002140) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies East China Engineering Science and Technology Co., Ltd. (SZSE:002140) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for East China Engineering Science and Technology

How Much Debt Does East China Engineering Science and Technology Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 East China Engineering Science and Technology had CN¥1.42b of debt, an increase on CN¥1.28b, over one year. However, its balance sheet shows it holds CN¥3.36b in cash, so it actually has CN¥1.95b net cash.

A Look At East China Engineering Science and Technology's Liabilities

Zooming in on the latest balance sheet data, we can see that East China Engineering Science and Technology had liabilities of CN¥9.98b due within 12 months and liabilities of CN¥1.03b due beyond that. Offsetting these obligations, it had cash of CN¥3.36b as well as receivables valued at CN¥3.28b due within 12 months. So its liabilities total CN¥4.37b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥5.91b, so it does suggest shareholders should keep an eye on East China Engineering Science and Technology's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, East China Engineering Science and Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, East China Engineering Science and Technology grew its EBIT by 7.4% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine East China Engineering Science and Technology'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While East China Engineering Science and Technology 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. Over the most recent three years, East China Engineering Science and Technology recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although East China Engineering Science and Technology'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¥1.95b. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in CN¥684m. So we are not troubled with East China Engineering Science and Technology's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for East China Engineering Science and Technology you should know about.

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.