Changmao Biochemical Engineering (HKG:954) Has A Rock Solid Balance Sheet

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. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Changmao Biochemical Engineering Company Limited (HKG:954) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

Check out our latest analysis for Changmao Biochemical Engineering

What Is Changmao Biochemical Engineering's Debt?

You can click the graphic below for the historical numbers, but it shows that Changmao Biochemical Engineering had CN¥500.0k of debt in June 2019, down from CN¥27.5m, one year before. However, it does have CN¥96.5m in cash offsetting this, leading to net cash of CN¥96.0m.

A Look At Changmao Biochemical Engineering's Liabilities

Zooming in on the latest balance sheet data, we can see that Changmao Biochemical Engineering had liabilities of CN¥88.1m due within 12 months and liabilities of CN¥2.23m due beyond that. Offsetting this, it had CN¥96.5m in cash and CN¥97.1m in receivables that were due within 12 months. So it actually has CN¥103.3m more liquid assets than total liabilities.

This excess liquidity suggests that Changmao Biochemical Engineering is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Changmao Biochemical Engineering has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Changmao Biochemical Engineering grew its EBIT by 550% 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 you can't view debt in total isolation; since Changmao Biochemical Engineering 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Changmao Biochemical Engineering 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. During the last three years, Changmao Biochemical Engineering generated free cash flow amounting to a very robust 94% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case Changmao Biochemical Engineering has CN¥96.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥51m, being 94% of its EBIT. The bottom line is that we do not find Changmao Biochemical Engineering's debt levels at all concerning. We'd be very excited to see if Changmao Biochemical Engineering insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.