Zhengzhou Coal Mining Machinery Group (HKG:564) Seems To Use Debt Quite Sensibly

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. We note that Zhengzhou Coal Mining Machinery Group Company Limited (HKG:564) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Zhengzhou Coal Mining Machinery Group

What Is Zhengzhou Coal Mining Machinery Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Zhengzhou Coal Mining Machinery Group had CN¥6.91b of debt, an increase on CN¥4.36b, over one year. However, it does have CN¥7.30b in cash offsetting this, leading to net cash of CN¥395.0m.

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

The latest balance sheet data shows that Zhengzhou Coal Mining Machinery Group had liabilities of CN¥13.2b due within a year, and liabilities of CN¥7.81b falling due after that. Offsetting these obligations, it had cash of CN¥7.30b as well as receivables valued at CN¥10.7b due within 12 months. So it has liabilities totalling CN¥3.05b more than its cash and near-term receivables, combined.

Given Zhengzhou Coal Mining Machinery Group has a market capitalization of CN¥18.7b, 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. Despite its noteworthy liabilities, Zhengzhou Coal Mining Machinery Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Zhengzhou Coal Mining Machinery Group has boosted its EBIT by 66%, thus reducing the spectre of future debt repayments. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Zhengzhou Coal Mining Machinery Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. 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 weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While Zhengzhou Coal Mining Machinery Group does have more liabilities than liquid assets, it also has net cash of CN¥395.0m. And we liked the look of last year's 66% year-on-year EBIT growth. So we don't think Zhengzhou Coal Mining Machinery Group's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 5 warning signs for Zhengzhou Coal Mining Machinery Group that you should be aware of before investing here.

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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