Chu Kong Petroleum and Natural Gas Steel Pipe Holdings (HKG:1938) Has No Shortage Of Debt

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.' 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 Chu Kong Petroleum and Natural Gas Steel Pipe Holdings Limited (HKG:1938) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Chu Kong Petroleum and Natural Gas Steel Pipe Holdings

What Is Chu Kong Petroleum and Natural Gas Steel Pipe Holdings's Debt?

The chart below, which you can click on for greater detail, shows that Chu Kong Petroleum and Natural Gas Steel Pipe Holdings had CN¥2.16b in debt in June 2023; about the same as the year before. However, because it has a cash reserve of CN¥87.3m, its net debt is less, at about CN¥2.07b.

A Look At Chu Kong Petroleum and Natural Gas Steel Pipe Holdings' Liabilities

The latest balance sheet data shows that Chu Kong Petroleum and Natural Gas Steel Pipe Holdings had liabilities of CN¥4.08b due within a year, and liabilities of CN¥1.76b falling due after that. On the other hand, it had cash of CN¥87.3m and CN¥510.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.24b.

This deficit casts a shadow over the CN¥177.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Chu Kong Petroleum and Natural Gas Steel Pipe Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.50 times and a disturbingly high net debt to EBITDA ratio of 19.3 hit our confidence in Chu Kong Petroleum and Natural Gas Steel Pipe Holdings like a one-two punch to the gut. The debt burden here is substantial. Even worse, Chu Kong Petroleum and Natural Gas Steel Pipe Holdings saw its EBIT tank 64% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Chu Kong Petroleum and Natural Gas Steel Pipe Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. During the last two years, Chu Kong Petroleum and Natural Gas Steel Pipe Holdings burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Chu Kong Petroleum and Natural Gas Steel Pipe Holdings's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its interest cover also fails to instill confidence. It looks to us like Chu Kong Petroleum and Natural Gas Steel Pipe Holdings carries a significant balance sheet burden. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Chu Kong Petroleum and Natural Gas Steel Pipe Holdings you should be aware of, and 1 of them shouldn't be ignored.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.