China BlueChemical (HKG:3983) Seems To Use Debt Rather Sparingly

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. We can see that China BlueChemical Ltd. (HKG:3983) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for China BlueChemical

How Much Debt Does China BlueChemical Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 China BlueChemical had CN¥2.00b of debt, an increase on CN¥1.61b, over one year. But it also has CN¥12.7b in cash to offset that, meaning it has CN¥10.7b net cash.

How Healthy Is China BlueChemical's Balance Sheet?

We can see from the most recent balance sheet that China BlueChemical had liabilities of CN¥3.09b falling due within a year, and liabilities of CN¥1.84b due beyond that. Offsetting these obligations, it had cash of CN¥12.7b as well as receivables valued at CN¥440.0m due within 12 months. So it actually has CN¥8.24b more liquid assets than total liabilities.

This surplus strongly suggests that China BlueChemical has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, China BlueChemical boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that China BlueChemical's load is not too heavy, because its EBIT was down 36% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept 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. Over the most recent three years, China BlueChemical recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case China BlueChemical has CN¥10.7b in net cash and a strong balance sheet. The cherry on top was that in converted 67% of that EBIT to free cash flow, bringing in CN¥598m. So we don't think China BlueChemical's use of debt is risky. 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. For instance, we've identified 3 warning signs for China BlueChemical (2 are potentially serious) you should be aware of.

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.