Kunlun Energy (HKG:135) Could Easily Take On More 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. We can see that Kunlun Energy Company Limited (HKG:135) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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.

View our latest analysis for Kunlun Energy

What Is Kunlun Energy's Debt?

The chart below, which you can click on for greater detail, shows that Kunlun Energy had CN¥25.1b in debt in December 2022; about the same as the year before. However, its balance sheet shows it holds CN¥39.5b in cash, so it actually has CN¥14.4b net cash.

How Healthy Is Kunlun Energy's Balance Sheet?

According to the last reported balance sheet, Kunlun Energy had liabilities of CN¥34.4b due within 12 months, and liabilities of CN¥23.8b due beyond 12 months. Offsetting these obligations, it had cash of CN¥39.5b as well as receivables valued at CN¥5.91b due within 12 months. So its liabilities total CN¥12.8b more than the combination of its cash and short-term receivables.

Kunlun Energy has a market capitalization of CN¥56.2b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Kunlun Energy also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Kunlun Energy has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. 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 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. While Kunlun Energy has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Kunlun Energy generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

Although Kunlun Energy's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥14.4b. And it impressed us with free cash flow of CN¥9.2b, being 82% of its EBIT. 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. For example - Kunlun Energy has 1 warning sign we think you should be aware of.

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.