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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that China Pipe Group Limited (HKG:380) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for China Pipe Group
How Much Debt Does China Pipe Group Carry?
As you can see below, at the end of June 2024, China Pipe Group had HK$63.0m of debt, up from HK$60.3m a year ago. Click the image for more detail. However, it does have HK$342.5m in cash offsetting this, leading to net cash of HK$279.5m.
How Strong Is China Pipe Group's Balance Sheet?
The latest balance sheet data shows that China Pipe Group had liabilities of HK$157.9m due within a year, and liabilities of HK$48.2m falling due after that. Offsetting these obligations, it had cash of HK$342.5m as well as receivables valued at HK$202.9m due within 12 months. So it can boast HK$339.3m more liquid assets than total liabilities.
This surplus liquidity suggests that China Pipe Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, China Pipe Group boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that China Pipe Group has boosted its EBIT by 38%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is China Pipe Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. China Pipe Group 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. Over the last three years, China Pipe Group recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
Summing Up
While we empathize with investors who find debt concerning, the bottom line is that China Pipe Group has net cash of HK$279.5m and plenty of liquid assets. And it impressed us with free cash flow of HK$77m, being 96% of its EBIT. The bottom line is that China Pipe Group's use of debt is absolutely fine. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - China Pipe Group has 1 warning sign we think you should be aware of.
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.