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

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies China Pipe Group Limited (HKG:380) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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.

View 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 China Pipe Group had HK$53.4m of debt in December 2022, down from HK$56.0m, one year before. But it also has HK$215.1m in cash to offset that, meaning it has HK$161.7m net cash.

How Strong Is China Pipe Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Pipe Group had liabilities of HK$149.9m due within 12 months and liabilities of HK$80.8m due beyond that. Offsetting these obligations, it had cash of HK$215.1m as well as receivables valued at HK$152.2m due within 12 months. So it can boast HK$136.6m more liquid assets than total liabilities.

This surplus strongly suggests that China Pipe Group has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. 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.

But the bad news is that China Pipe Group has seen its EBIT plunge 17% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China Pipe Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. During the last three years, China Pipe Group generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, the bottom line is that China Pipe Group has net cash of HK$161.7m and plenty of liquid assets. The cherry on top was that in converted 80% of that EBIT to free cash flow, bringing in HK$65m. So is China Pipe Group's debt a risk? It doesn't seem so to us. 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. For example - China Pipe Group has 2 warning signs we think you should be aware of.

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.