Here's Why China Zhonghua Geotechnical Engineering Group (SZSE:002542) Can Afford Some 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.' 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. We can see that China Zhonghua Geotechnical Engineering Group Co., Ltd. (SZSE:002542) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does China Zhonghua Geotechnical Engineering Group Carry?

The image below, which you can click on for greater detail, shows that China Zhonghua Geotechnical Engineering Group had debt of CN¥2.60b at the end of September 2024, a reduction from CN¥3.06b over a year. On the flip side, it has CN¥512.0m in cash leading to net debt of about CN¥2.09b.

How Healthy Is China Zhonghua Geotechnical Engineering Group's Balance Sheet?

According to the last reported balance sheet, China Zhonghua Geotechnical Engineering Group had liabilities of CN¥4.00b due within 12 months, and liabilities of CN¥1.15b due beyond 12 months. Offsetting these obligations, it had cash of CN¥512.0m as well as receivables valued at CN¥4.36b due within 12 months. So its liabilities total CN¥280.7m more than the combination of its cash and short-term receivables.

Given China Zhonghua Geotechnical Engineering Group has a market capitalization of CN¥6.65b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China Zhonghua Geotechnical Engineering Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Check out our latest analysis for China Zhonghua Geotechnical Engineering Group

Over 12 months, China Zhonghua Geotechnical Engineering Group made a loss at the EBIT level, and saw its revenue drop to CN¥2.1b, which is a fall of 15%. That's not what we would hope to see.

Caveat Emptor

While China Zhonghua Geotechnical Engineering Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CN¥547m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of CN¥631m into a profit. In the meantime, we consider the stock very risky. 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 Zhonghua Geotechnical Engineering Group 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.