SINOPEC Engineering (Group) (HKG:2386) Has A Rock Solid Balance Sheet

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.' 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 SINOPEC Engineering (Group) Co., Ltd. (HKG:2386) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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)

What Is SINOPEC Engineering (Group)'s Net Debt?

The image below, which you can click on for greater detail, shows that at June 2021 SINOPEC Engineering (Group) had debt of CN¥174.6m, up from none in one year. But on the other hand it also has CN¥15.3b in cash, leading to a CN¥15.1b net cash position.

How Healthy Is SINOPEC Engineering (Group)'s Balance Sheet?

The latest balance sheet data shows that SINOPEC Engineering (Group) had liabilities of CN¥41.0b due within a year, and liabilities of CN¥2.46b falling due after that. On the other hand, it had cash of CN¥15.3b and CN¥40.5b worth of receivables due within a year. So it actually has CN¥12.3b more liquid assets than total liabilities.

This luscious liquidity implies that SINOPEC Engineering (Group)'s balance sheet is sturdy like a giant sequoia tree. 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!

Another good sign is that SINOPEC Engineering (Group) has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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¥15.1b, as well as more liquid assets than liabilities. The cherry on top was that in converted 133% of that EBIT to free cash flow, bringing in CN¥2.4b. The bottom line is that SINOPEC Engineering (Group)'s use of debt is absolutely fine. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for SINOPEC Engineering (Group) 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.

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.

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