Here's Why Zhengzhou Coal Mining Machinery Group (HKG:564) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Zhengzhou Coal Mining Machinery Group Company Limited (HKG:564) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Zhengzhou Coal Mining Machinery Group

What Is Zhengzhou Coal Mining Machinery Group's Debt?

The chart below, which you can click on for greater detail, shows that Zhengzhou Coal Mining Machinery Group had CN¥5.22b in debt in June 2021; about the same as the year before. But on the other hand it also has CN¥5.32b in cash, leading to a CN¥93.0m net cash position.

How Healthy Is Zhengzhou Coal Mining Machinery Group's Balance Sheet?

According to the last reported balance sheet, Zhengzhou Coal Mining Machinery Group had liabilities of CN¥12.8b due within 12 months, and liabilities of CN¥7.01b due beyond 12 months. On the other hand, it had cash of CN¥5.32b and CN¥11.7b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.72b.

Given Zhengzhou Coal Mining Machinery Group has a market capitalization of CN¥19.8b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Zhengzhou Coal Mining Machinery Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Zhengzhou Coal Mining Machinery Group has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Zhengzhou Coal Mining Machinery Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Zhengzhou Coal Mining Machinery 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. During the last three years, Zhengzhou Coal Mining Machinery Group produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While Zhengzhou Coal Mining Machinery Group does have more liabilities than liquid assets, it also has net cash of CN¥93.0m. And it impressed us with its EBIT growth of 23% over the last year. So is Zhengzhou Coal Mining Machinery 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 - Zhengzhou Coal Mining Machinery Group has 4 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.

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.

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