China Oilfield Services (HKG:2883) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that China Oilfield Services Limited (HKG:2883) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for China Oilfield Services

What Is China Oilfield Services's Debt?

As you can see below, China Oilfield Services had CN¥22.0b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CN¥9.88b in cash leading to net debt of about CN¥12.1b.

A Look At China Oilfield Services' Liabilities

We can see from the most recent balance sheet that China Oilfield Services had liabilities of CN¥22.7b falling due within a year, and liabilities of CN¥17.4b due beyond that. Offsetting these obligations, it had cash of CN¥9.88b as well as receivables valued at CN¥20.3b due within 12 months. So it has liabilities totalling CN¥9.98b more than its cash and near-term receivables, combined.

Since publicly traded China Oilfield Services shares are worth a total of CN¥55.7b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). 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).

With a debt to EBITDA ratio of 1.6, China Oilfield Services uses debt artfully but responsibly. And the alluring interest cover (EBIT of 7.2 times interest expense) certainly does not do anything to dispel this impression. And we also note warmly that China Oilfield Services grew its EBIT by 20% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if China Oilfield Services can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, China Oilfield Services actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

China Oilfield Services's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Looking at the bigger picture, we think China Oilfield Services's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you're interested in China Oilfield Services, you may well want to click here to check an interactive graph of its earnings per share history.

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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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.