These 4 Measures Indicate That Zhengzhou Coal Mining Machinery Group (HKG:564) 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. Importantly, Zhengzhou Coal Mining Machinery Group Company Limited (HKG:564) does carry 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Zhengzhou Coal Mining Machinery Group

How Much Debt Does Zhengzhou Coal Mining Machinery Group Carry?

The image below, which you can click on for greater detail, shows that Zhengzhou Coal Mining Machinery Group had debt of CN¥6.10b at the end of March 2022, a reduction from CN¥7.03b over a year. But on the other hand it also has CN¥7.74b in cash, leading to a CN¥1.64b net cash position.

A Look At Zhengzhou Coal Mining Machinery Group's Liabilities

The latest balance sheet data shows that Zhengzhou Coal Mining Machinery Group had liabilities of CN¥15.2b due within a year, and liabilities of CN¥5.51b falling due after that. On the other hand, it had cash of CN¥7.74b and CN¥10.7b worth of receivables due within a year. So it has liabilities totalling CN¥2.26b more than its cash and near-term receivables, combined.

Of course, Zhengzhou Coal Mining Machinery Group has a market capitalization of CN¥21.2b, so these liabilities are probably manageable. 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.

On the other hand, Zhengzhou Coal Mining Machinery Group's EBIT dived 17%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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 73% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While Zhengzhou Coal Mining Machinery Group does have more liabilities than liquid assets, it also has net cash of CN¥1.64b. The cherry on top was that in converted 73% of that EBIT to free cash flow, bringing in CN¥2.1b. So we are not troubled with Zhengzhou Coal Mining Machinery Group's debt use. 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. For example - Zhengzhou Coal Mining Machinery Group has 2 warning signs we think you should be aware of.

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.