Stock Analysis

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

SEHK:564
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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. 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?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, 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 2021 Zhengzhou Coal Mining Machinery Group had debt of CN¥6.34b, up from CN¥5.76b in one year. However, it also had CN¥5.59b in cash, and so its net debt is CN¥751.7m.

debt-equity-history-analysis
SEHK:564 Debt to Equity History January 26th 2022

A Look At Zhengzhou Coal Mining Machinery Group's Liabilities

We can see from the most recent balance sheet that Zhengzhou Coal Mining Machinery Group had liabilities of CN¥13.0b falling due within a year, and liabilities of CN¥7.68b due beyond that. Offsetting this, it had CN¥5.59b in cash and CN¥10.9b in receivables that were due within 12 months. So its liabilities total CN¥4.17b more than the combination of its cash and short-term receivables.

Zhengzhou Coal Mining Machinery Group has a market capitalization of CN¥20.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Zhengzhou Coal Mining Machinery Group's net debt is only 0.18 times its EBITDA. And its EBIT easily covers its interest expense, being 996 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Zhengzhou Coal Mining Machinery Group has boosted its EBIT by 54%, thus reducing the spectre of future debt repayments. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Zhengzhou Coal Mining Machinery Group's free cash flow amounted to 49% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Zhengzhou Coal Mining Machinery Group's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, Zhengzhou Coal Mining Machinery Group seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. To that end, you should be aware of the 3 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.

Valuation is complex, but we're helping make it simple.

Find out whether Zhengzhou Coal Mining Machinery Group is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.