Is Shandong Molong Petroleum Machinery (HKG:568) Using Debt In A Risky Way?

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.' 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, Shandong Molong Petroleum Machinery Company Limited (HKG:568) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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, 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.

Check out our latest analysis for Shandong Molong Petroleum Machinery

What Is Shandong Molong Petroleum Machinery's Debt?

The image below, which you can click on for greater detail, shows that Shandong Molong Petroleum Machinery had debt of CN¥1.63b at the end of March 2024, a reduction from CN¥2.16b over a year. However, it also had CN¥193.0m in cash, and so its net debt is CN¥1.43b.

How Healthy Is Shandong Molong Petroleum Machinery's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shandong Molong Petroleum Machinery had liabilities of CN¥2.31b due within 12 months and liabilities of CN¥41.1m due beyond that. Offsetting these obligations, it had cash of CN¥193.0m as well as receivables valued at CN¥638.0m due within 12 months. So it has liabilities totalling CN¥1.52b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's CN¥1.04b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shandong Molong Petroleum Machinery's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Shandong Molong Petroleum Machinery made a loss at the EBIT level, and saw its revenue drop to CN¥1.1b, which is a fall of 58%. To be frank that doesn't bode well.

Caveat Emptor

While Shandong Molong Petroleum Machinery's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable CN¥185m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of CN¥263m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. 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. We've identified 2 warning signs with Shandong Molong Petroleum Machinery (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.

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