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

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. 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?

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Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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

As you can see below, at the end of December 2024, SINOPEC Engineering (Group) had CN¥150.1m of debt, up from CN¥102.2m a year ago. Click the image for more detail. However, it does have CN¥21.4b in cash offsetting this, leading to net cash of CN¥21.3b.

A Look At SINOPEC Engineering (Group)'s Liabilities

We can see from the most recent balance sheet that SINOPEC Engineering (Group) had liabilities of CN¥47.9b falling due within a year, and liabilities of CN¥2.08b due beyond that. Offsetting this, it had CN¥21.4b in cash and CN¥42.4b in receivables that were due within 12 months. So it can boast CN¥13.9b 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. Succinctly put, SINOPEC Engineering (Group) boasts net cash, so it's fair to say it does not have a heavy debt load!

See our latest analysis for SINOPEC Engineering (Group)

But the bad news is that SINOPEC Engineering (Group) has seen its EBIT plunge 10% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. 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 company can only pay off debt with cold hard cash, not accounting profits. 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. Over the last three years, SINOPEC Engineering (Group) actually produced more free cash flow than EBIT. 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¥21.3b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 123% of that EBIT to free cash flow, bringing in -CN¥2.6b. 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, we've discovered 2 warning signs for SINOPEC Engineering (Group) (1 doesn't sit too well with us!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.