We Think Shandong Molong Petroleum Machinery (HKG:568) Has A Fair Chunk Of 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.' 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. As with many other companies Shandong Molong Petroleum Machinery Company Limited (HKG:568) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Shandong Molong Petroleum Machinery

What Is Shandong Molong Petroleum Machinery's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2022 Shandong Molong Petroleum Machinery had debt of CN¥2.23b, up from CN¥2.03b in one year. On the flip side, it has CN¥620.3m in cash leading to net debt of about CN¥1.61b.

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

According to the last reported balance sheet, Shandong Molong Petroleum Machinery had liabilities of CN¥3.36b due within 12 months, and liabilities of CN¥84.7m due beyond 12 months. Offsetting these obligations, it had cash of CN¥620.3m as well as receivables valued at CN¥535.8m due within 12 months. So it has liabilities totalling CN¥2.28b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥3.40b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shandong Molong Petroleum Machinery will need earnings to service that debt. 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.

In the last year Shandong Molong Petroleum Machinery had a loss before interest and tax, and actually shrunk its revenue by 19%, to CN¥3.0b. We would much prefer see growth.

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. Its EBIT loss was a whopping CN¥359m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of CN¥528m into a profit. So in short it's a really risky stock. 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. We've identified 1 warning sign with Shandong Molong Petroleum Machinery , and understanding them should be part of your investment process.

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.