COSCO SHIPPING Energy Transportation (HKG:1138) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that COSCO SHIPPING Energy Transportation Co., Ltd. (HKG:1138) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for COSCO SHIPPING Energy Transportation

What Is COSCO SHIPPING Energy Transportation's Debt?

As you can see below, COSCO SHIPPING Energy Transportation had CN¥23.0b of debt at March 2021, down from CN¥31.1b a year prior. However, it does have CN¥3.14b in cash offsetting this, leading to net debt of about CN¥19.9b.

How Healthy Is COSCO SHIPPING Energy Transportation's Balance Sheet?

The latest balance sheet data shows that COSCO SHIPPING Energy Transportation had liabilities of CN¥9.79b due within a year, and liabilities of CN¥19.9b falling due after that. Offsetting this, it had CN¥3.14b in cash and CN¥1.96b in receivables that were due within 12 months. So it has liabilities totalling CN¥24.6b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥25.8b, so it does suggest shareholders should keep an eye on COSCO SHIPPING Energy Transportation's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

COSCO SHIPPING Energy Transportation's net debt is 3.3 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. Pleasingly, COSCO SHIPPING Energy Transportation is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 100% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine COSCO SHIPPING Energy Transportation'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, COSCO SHIPPING Energy Transportation produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

COSCO SHIPPING Energy Transportation's interest cover was a real positive on this analysis, as was its EBIT growth rate. Having said that, its level of total liabilities somewhat sensitizes us to potential future risks to the balance sheet. Considering this range of data points, we think COSCO SHIPPING Energy Transportation is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Case in point: We've spotted 3 warning signs for COSCO SHIPPING Energy Transportation 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.

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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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