Is Changzheng Engineering TechnologyLtd (SHSE:603698) A Risky Investment?

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. As with many other companies Changzheng Engineering Technology Co.,Ltd (SHSE:603698) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Changzheng Engineering TechnologyLtd

What Is Changzheng Engineering TechnologyLtd's Net Debt?

As you can see below, at the end of September 2024, Changzheng Engineering TechnologyLtd had CN¥1.01b of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has CN¥2.15b in cash, leading to a CN¥1.14b net cash position.

How Strong Is Changzheng Engineering TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Changzheng Engineering TechnologyLtd had liabilities of CN¥1.74b due within 12 months, and liabilities of CN¥1.17b due beyond 12 months. Offsetting this, it had CN¥2.15b in cash and CN¥1.14b in receivables that were due within 12 months. So it can boast CN¥386.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Changzheng Engineering TechnologyLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Changzheng Engineering TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Changzheng Engineering TechnologyLtd's saving grace is its low debt levels, because its EBIT has tanked 38% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Changzheng Engineering TechnologyLtd'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Changzheng Engineering TechnologyLtd 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, Changzheng Engineering TechnologyLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Changzheng Engineering TechnologyLtd has CN¥1.14b in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Changzheng Engineering TechnologyLtd's balance sheet. 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. We've identified 2 warning signs with Changzheng Engineering TechnologyLtd (at least 1 which is significant) , and understanding them should be part of your investment process.

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.