These 4 Measures Indicate That SINOPEC Engineering (Group) (HKG:2386) Is Using Debt Safely

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.' 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. Importantly, SINOPEC Engineering (Group) Co., Ltd. (HKG:2386) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for SINOPEC Engineering (Group)

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

As you can see below, SINOPEC Engineering (Group) had CN¥129.2m of debt at June 2024, down from CN¥154.2m a year prior. But it also has CN¥20.8b in cash to offset that, meaning it has CN¥20.7b net cash.

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

According to the last reported balance sheet, SINOPEC Engineering (Group) had liabilities of CN¥48.0b due within 12 months, and liabilities of CN¥1.95b due beyond 12 months. Offsetting this, it had CN¥20.8b in cash and CN¥41.2b in receivables that were due within 12 months. So it can boast CN¥12.0b more liquid assets than total liabilities.

This excess liquidity is a great indication that SINOPEC Engineering (Group)'s balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. 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.

In addition to that, we're happy to report that SINOPEC Engineering (Group) has boosted its EBIT by 35%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

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¥20.7b, as well as more liquid assets than liabilities. The cherry on top was that in converted 183% of that EBIT to free cash flow, bringing in -CN¥1.1b. At the end of the day we're not concerned about SINOPEC Engineering (Group)'s debt. 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) (1 is potentially serious) 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.

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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.