Does Kunlun Energy (HKG:135) Have A Healthy Balance Sheet?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Kunlun Energy Company Limited (HKG:135) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Kunlun Energy

What Is Kunlun Energy's Debt?

As you can see below, Kunlun Energy had CN¥24.5b of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has CN¥45.6b in cash, leading to a CN¥21.1b net cash position.

How Healthy Is Kunlun Energy's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kunlun Energy had liabilities of CN¥34.6b due within 12 months and liabilities of CN¥23.2b due beyond that. On the other hand, it had cash of CN¥45.6b and CN¥5.16b worth of receivables due within a year. So it has liabilities totalling CN¥6.99b more than its cash and near-term receivables, combined.

Of course, Kunlun Energy has a market capitalization of CN¥58.5b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Kunlun Energy boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Kunlun Energy grew its EBIT by 5.4% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Kunlun Energy can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Kunlun Energy 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, Kunlun Energy produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Kunlun Energy does have more liabilities than liquid assets, it also has net cash of CN¥21.1b. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in CN¥9.2b. So we don't think Kunlun Energy's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Kunlun Energy you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.