China BlueChemical (HKG:3983) Could Easily Take On More Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, China BlueChemical Ltd. (HKG:3983) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for China BlueChemical

What Is China BlueChemical's Net Debt?

As you can see below, China BlueChemical had CN¥1.02b of debt at December 2021, down from CN¥1.95b a year prior. However, its balance sheet shows it holds CN¥11.2b in cash, so it actually has CN¥10.2b net cash.

How Strong Is China BlueChemical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China BlueChemical had liabilities of CN¥3.44b due within 12 months and liabilities of CN¥1.07b due beyond that. Offsetting these obligations, it had cash of CN¥11.2b as well as receivables valued at CN¥653.9m due within 12 months. So it actually has CN¥7.37b more liquid assets than total liabilities.

This excess liquidity is a great indication that China BlueChemical's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, China BlueChemical boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that China BlueChemical grew its EBIT by 178% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine China BlueChemical's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. China BlueChemical may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, China BlueChemical's free cash flow amounted to 47% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that China BlueChemical has net cash of CN¥10.2b, as well as more liquid assets than liabilities. And we liked the look of last year's 178% year-on-year EBIT growth. The bottom line is that we do not find China BlueChemical's debt levels at all concerning. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that China BlueChemical is showing 2 warning signs in our investment analysis , and 1 of those is 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.