Chongqing Machinery & Electric (HKG:2722) Is Making Moderate Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Chongqing Machinery & Electric Co., Ltd. (HKG:2722) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Chongqing Machinery & Electric

What Is Chongqing Machinery & Electric's Net Debt?

The image below, which you can click on for greater detail, shows that Chongqing Machinery & Electric had debt of CN¥2.88b at the end of June 2022, a reduction from CN¥3.03b over a year. However, because it has a cash reserve of CN¥2.72b, its net debt is less, at about CN¥153.5m.

How Healthy Is Chongqing Machinery & Electric's Balance Sheet?

We can see from the most recent balance sheet that Chongqing Machinery & Electric had liabilities of CN¥6.78b falling due within a year, and liabilities of CN¥2.18b due beyond that. Offsetting this, it had CN¥2.72b in cash and CN¥5.82b in receivables that were due within 12 months. So it has liabilities totalling CN¥411.3m more than its cash and near-term receivables, combined.

Chongqing Machinery & Electric has a market capitalization of CN¥1.95b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is Chongqing Machinery & Electric's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Chongqing Machinery & Electric had a loss before interest and tax, and actually shrunk its revenue by 3.4%, to CN¥7.1b. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months Chongqing Machinery & Electric produced an earnings before interest and tax (EBIT) loss. Indeed, it lost CN¥67m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Surprisingly, we note that it actually reported positive free cash flow of CN¥631m and a profit of CN¥334m. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. 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 3 warning signs for Chongqing Machinery & Electric (1 is significant!) that you should be aware of before investing here.

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.

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.