Is Chu Kong Petroleum and Natural Gas Steel Pipe Holdings (HKG:1938) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Chu Kong Petroleum and Natural Gas Steel Pipe Holdings Limited (HKG:1938) does carry debt. But the real question is whether this debt is making the company risky.

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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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Chu Kong Petroleum and Natural Gas Steel Pipe Holdings Carry?

The chart below, which you can click on for greater detail, shows that Chu Kong Petroleum and Natural Gas Steel Pipe Holdings had CN¥1.87b in debt in December 2024; about the same as the year before. However, it does have CN¥280.9m in cash offsetting this, leading to net debt of about CN¥1.59b.

How Healthy Is Chu Kong Petroleum and Natural Gas Steel Pipe Holdings' Balance Sheet?

The latest balance sheet data shows that Chu Kong Petroleum and Natural Gas Steel Pipe Holdings had liabilities of CN¥4.11b due within a year, and liabilities of CN¥1.15b falling due after that. Offsetting this, it had CN¥280.9m in cash and CN¥376.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.61b.

This deficit casts a shadow over the CN¥196.1m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Chu Kong Petroleum and Natural Gas Steel Pipe Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

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

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Chu Kong Petroleum and Natural Gas Steel Pipe Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (10.9), and fairly weak interest coverage, since EBIT is just 0.74 times the interest expense. This means we'd consider it to have a heavy debt load. However, it should be some comfort for shareholders to recall that Chu Kong Petroleum and Natural Gas Steel Pipe Holdings actually grew its EBIT by a hefty 130%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Chu Kong Petroleum and Natural Gas Steel Pipe Holdings will need earnings to service that debt. 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. Over the last three years, Chu Kong Petroleum and Natural Gas Steel Pipe Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, Chu Kong Petroleum and Natural Gas Steel Pipe Holdings's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Chu Kong Petroleum and Natural Gas Steel Pipe Holdings's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Chu Kong Petroleum and Natural Gas Steel Pipe Holdings (including 1 which is a bit concerning) .

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.