SINOPEC Engineering (Group) (HKG:2386) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that SINOPEC Engineering (Group) Co., Ltd. (HKG:2386) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Debt?

You can click the graphic below for the historical numbers, but it shows that SINOPEC Engineering (Group) had CN¥63.8m of debt in December 2021, down from CN¥163.1m, one year before. However, it does have CN¥18.7b in cash offsetting this, leading to net cash of CN¥18.6b.

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

According to the last reported balance sheet, SINOPEC Engineering (Group) had liabilities of CN¥41.4b due within 12 months, and liabilities of CN¥2.42b due beyond 12 months. On the other hand, it had cash of CN¥18.7b and CN¥38.7b worth of receivables due within a year. So it actually has CN¥13.6b more liquid assets than total liabilities.

This luscious liquidity implies that SINOPEC Engineering (Group)'s balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that SINOPEC Engineering (Group) has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for SINOPEC Engineering (Group) if management cannot prevent a repeat of the 25% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if SINOPEC Engineering (Group) can strengthen its balance sheet over time. 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. During the last three years, SINOPEC Engineering (Group) generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case SINOPEC Engineering (Group) has CN¥18.6b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in CN¥2.3b. So is SINOPEC Engineering (Group)'s debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - SINOPEC Engineering (Group) has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.