We Think SINOPEC Engineering (Group) (HKG:2386) Can Manage Its Debt With Ease

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 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. Importantly, SINOPEC Engineering (Group) Co., Ltd. (HKG:2386) does carry 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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 at December 2020 SINOPEC Engineering (Group) had debt of CN¥163.1m, up from none in one year. But on the other hand it also has CN¥16.7b in cash, leading to a CN¥16.6b net cash position.

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

According to the last reported balance sheet, SINOPEC Engineering (Group) had liabilities of CN¥40.7b due within 12 months, and liabilities of CN¥2.54b due beyond 12 months. Offsetting this, it had CN¥16.7b in cash and CN¥39.3b in receivables that were due within 12 months. So it can boast CN¥12.8b 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. 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.

And we also note warmly that SINOPEC Engineering (Group) grew its EBIT by 16% last year, making its debt load easier to handle. 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'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. While SINOPEC Engineering (Group) has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. 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 it is always sensible to investigate a company's debt, in this case SINOPEC Engineering (Group) has CN¥16.6b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥2.5b, being 163% of its EBIT. The bottom line is that SINOPEC Engineering (Group)'s use of debt is absolutely fine. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - SINOPEC Engineering (Group) has 1 warning sign we think you should be aware of.

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. 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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