These 4 Measures Indicate That China Pipe Group (HKG:380) Is Using Debt Reasonably Well

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.' 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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for China Pipe Group

What Is China Pipe Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 China Pipe Group had HK$60.3m of debt, an increase on HK$47.6m, over one year. However, its balance sheet shows it holds HK$223.4m in cash, so it actually has HK$163.2m net cash.

How Healthy Is China Pipe Group's Balance Sheet?

We can see from the most recent balance sheet that China Pipe Group had liabilities of HK$178.8m falling due within a year, and liabilities of HK$69.5m due beyond that. Offsetting these obligations, it had cash of HK$223.4m as well as receivables valued at HK$183.1m due within 12 months. So it can boast HK$158.3m 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). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, China Pipe Group boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for China Pipe Group if management cannot prevent a repeat of the 34% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. China Pipe 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 most recent three years, China Pipe Group recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Pipe Group has HK$163.2m in net cash and a strong balance sheet. So we don't think China Pipe Group's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that China Pipe Group is showing 1 warning sign in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.