We Think Zhengzhou Coal Mining Machinery Group (HKG:564) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Zhengzhou Coal Mining Machinery Group Company Limited (HKG:564) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

View 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 at September 2020 Zhengzhou Coal Mining Machinery Group had debt of CN¥5.61b, up from CN¥3.31b in one year. But on the other hand it also has CN¥6.58b in cash, leading to a CN¥969.2m 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¥12.5b due within a year, and liabilities of CN¥5.84b falling due after that. Offsetting this, it had CN¥6.58b in cash and CN¥10.7b in receivables that were due within 12 months. So its liabilities total CN¥1.08b more than the combination of its cash and short-term receivables.

Since publicly traded Zhengzhou Coal Mining Machinery Group shares are worth a total of CN¥16.2b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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 top of that, Zhengzhou Coal Mining Machinery Group grew its EBIT by 47% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Zhengzhou Coal Mining Machinery Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. In the last three years, Zhengzhou Coal Mining Machinery Group's free cash flow amounted to 39% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Zhengzhou Coal Mining Machinery Group has CN¥969.2m in net cash. And it impressed us with its EBIT growth of 47% over the last year. So we don't think Zhengzhou Coal Mining Machinery Group's use of debt is risky. 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. To that end, you should be aware of the 4 warning signs we've spotted with Zhengzhou Coal Mining Machinery Group .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. 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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