SINOPEC Engineering (Group) (HKG:2386) Could Easily Take On More Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that SINOPEC Engineering (Group) Co., Ltd. (HKG:2386) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for SINOPEC Engineering (Group)

How Much Debt Does SINOPEC Engineering (Group) Carry?

The image below, which you can click on for greater detail, shows that SINOPEC Engineering (Group) had debt of CN¥102.2m at the end of December 2023, a reduction from CN¥142.0m over a year. But on the other hand it also has CN¥24.9b in cash, leading to a CN¥24.8b net cash position.

A Look At SINOPEC Engineering (Group)'s Liabilities

The latest balance sheet data shows that SINOPEC Engineering (Group) had liabilities of CN¥48.0b due within a year, and liabilities of CN¥2.15b falling due after that. Offsetting these obligations, it had cash of CN¥24.9b as well as receivables valued at CN¥39.3b due within 12 months. So it actually has CN¥14.0b more liquid assets than total liabilities.

This surplus liquidity suggests that SINOPEC Engineering (Group)'s balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, SINOPEC Engineering (Group) boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, SINOPEC Engineering (Group) grew its EBIT by 7.4% in the last year, making that debt load look even more manageable. 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 SINOPEC Engineering (Group)'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. SINOPEC Engineering (Group) 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. Happily for any shareholders, SINOPEC Engineering (Group) actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that SINOPEC Engineering (Group) has net cash of CN¥24.8b, as well as more liquid assets than liabilities. The cherry on top was that in converted 219% of that EBIT to free cash flow, bringing in CN¥2.1b. When it comes to SINOPEC Engineering (Group)'s debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. Be aware that SINOPEC Engineering (Group) is showing 1 warning sign in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.