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

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. Importantly, SINOPEC Engineering (Group) Co., Ltd. (HKG:2386) does carry debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for SINOPEC Engineering (Group)

What Is SINOPEC Engineering (Group)'s Debt?

As you can see below, SINOPEC Engineering (Group) had CN¥134.2m of debt at June 2022, down from CN¥174.6m a year prior. However, its balance sheet shows it holds CN¥17.4b in cash, so it actually has CN¥17.3b net cash.

A Look At SINOPEC Engineering (Group)'s Liabilities

The latest balance sheet data shows that SINOPEC Engineering (Group) had liabilities of CN¥40.4b due within a year, and liabilities of CN¥2.35b falling due after that. Offsetting these obligations, it had cash of CN¥17.4b as well as receivables valued at CN¥40.3b due within 12 months. So it actually has CN¥15.0b more liquid assets than total liabilities.

This surplus strongly suggests that SINOPEC Engineering (Group) has a rock-solid balance sheet (and the debt is of no concern whatsoever). 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!

It is just as well that SINOPEC Engineering (Group)'s load is not too heavy, because its EBIT was down 31% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if SINOPEC Engineering (Group) can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. 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 it is always sensible to investigate a company's debt, in this case SINOPEC Engineering (Group) has CN¥17.3b in net cash and a strong balance sheet. And it impressed us with free cash flow of CN¥2.7b, being 139% of its EBIT. So we don't think SINOPEC Engineering (Group)'s use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. 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...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.