Does China Oil And Gas Group (HKG:603) 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.' 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. Importantly, China Oil And Gas Group Limited (HKG:603) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for China Oil And Gas Group

What Is China Oil And Gas Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that China Oil And Gas Group had HK$8.57b of debt in June 2022, down from HK$10.6b, one year before. However, it does have HK$3.69b in cash offsetting this, leading to net debt of about HK$4.88b.

A Look At China Oil And Gas Group's Liabilities

We can see from the most recent balance sheet that China Oil And Gas Group had liabilities of HK$6.15b falling due within a year, and liabilities of HK$7.45b due beyond that. Offsetting this, it had HK$3.69b in cash and HK$2.60b in receivables that were due within 12 months. So it has liabilities totalling HK$7.31b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the HK$1.35b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, China Oil And Gas Group would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

China Oil And Gas Group has net debt to EBITDA of 2.7 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 9.5 suggests it can easily service that debt. Notably, China Oil And Gas Group's EBIT launched higher than Elon Musk, gaining a whopping 136% on last year. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China Oil And Gas Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, China Oil And Gas Group produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

China Oil And Gas Group's level of total liabilities and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. It's also worth noting that China Oil And Gas Group is in the Gas Utilities industry, which is often considered to be quite defensive. We think that China Oil And Gas Group's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for China Oil And Gas Group you should know about.

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.