Kunlun Energy (HKG:135) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. 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?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Kunlun Energy

What Is Kunlun Energy's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Kunlun Energy had CN¥25.6b of debt in June 2021, down from CN¥35.3b, one year before. But on the other hand it also has CN¥48.6b in cash, leading to a CN¥22.9b net cash position.

How Healthy Is Kunlun Energy's Balance Sheet?

According to the last reported balance sheet, Kunlun Energy had liabilities of CN¥50.1b due within 12 months, and liabilities of CN¥23.8b due beyond 12 months. Offsetting these obligations, it had cash of CN¥48.6b as well as receivables valued at CN¥4.02b due within 12 months. So it has liabilities totalling CN¥21.3b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Kunlun Energy is worth CN¥53.2b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Kunlun Energy boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Kunlun Energy grew its EBIT by 267% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kunlun Energy'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. 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 generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

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¥22.9b. The cherry on top was that in converted 85% of that EBIT to free cash flow, bringing in CN¥6.5b. So is Kunlun Energy's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 2 warning signs for Kunlun Energy (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

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.

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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.