China Pipe Group (HKG:380) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies China Pipe Group Limited (HKG:380) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for China Pipe Group

What Is China Pipe Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 China Pipe Group had HK$51.2m of debt, an increase on HK$45.9m, over one year. However, it does have HK$146.4m in cash offsetting this, leading to net cash of HK$95.2m.

A Look At China Pipe Group's Liabilities

According to the last reported balance sheet, China Pipe Group had liabilities of HK$172.5m due within 12 months, and liabilities of HK$92.9m due beyond 12 months. Offsetting these obligations, it had cash of HK$146.4m as well as receivables valued at HK$153.7m due within 12 months. So it actually has HK$34.7m more liquid assets than total liabilities.

This surplus suggests that China Pipe Group is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that China Pipe Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, China Pipe Group grew its EBIT by 179% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since China Pipe Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While China Pipe 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. Over the last three years, China Pipe Group recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case China Pipe Group has HK$95.2m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 98% of that EBIT to free cash flow, bringing in -HK$19m. When it comes to China Pipe Group's debt, we sufficiently relaxed that our mind turns to the jacuzzi. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for China Pipe Group (of which 1 doesn't sit too well with us!) 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.

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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.