These 4 Measures Indicate That China Petroleum Engineering (SHSE:600339) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, China Petroleum Engineering Corporation (SHSE:600339) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for China Petroleum Engineering

What Is China Petroleum Engineering's Debt?

As you can see below, at the end of June 2024, China Petroleum Engineering had CN¥4.00b of debt, up from CN¥1.51b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥28.7b in cash, so it actually has CN¥24.7b net cash.

How Strong Is China Petroleum Engineering's Balance Sheet?

According to the last reported balance sheet, China Petroleum Engineering had liabilities of CN¥77.2b due within 12 months, and liabilities of CN¥5.87b due beyond 12 months. Offsetting this, it had CN¥28.7b in cash and CN¥46.4b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥8.04b.

China Petroleum Engineering has a market capitalization of CN¥17.0b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, China Petroleum Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, China Petroleum Engineering's EBIT dived 15%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Petroleum Engineering can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While China Petroleum Engineering 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. Happily for any shareholders, China Petroleum Engineering actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although China Petroleum 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¥24.7b. And it impressed us with free cash flow of CN¥5.3b, being 155% of its EBIT. So we don't have any problem with China Petroleum 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 instance, we've identified 1 warning sign for China Petroleum Engineering that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.