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 CNOOC Limited (HKG:883) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.
How Much Debt Does CNOOC Carry?
You can click the graphic below for the historical numbers, but it shows that CNOOC had CN¥81.3b of debt in December 2024, down from CN¥110.1b, one year before. However, its balance sheet shows it holds CN¥200.0b in cash, so it actually has CN¥118.6b net cash.
A Look At CNOOC's Liabilities
According to the last reported balance sheet, CNOOC had liabilities of CN¥118.9b due within 12 months, and liabilities of CN¥188.0b due beyond 12 months. Offsetting these obligations, it had cash of CN¥200.0b as well as receivables valued at CN¥33.7b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥73.2b.
Since publicly traded CNOOC shares are worth a very impressive total of CN¥763.9b, it seems unlikely that this level of liabilities would be a major threat. 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, CNOOC boasts net cash, so it's fair to say it does not have a heavy debt load!
See our latest analysis for CNOOC
Also good is that CNOOC grew its EBIT at 15% over the last year, further increasing its ability to manage 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 CNOOC 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While CNOOC 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. Over the most recent three years, CNOOC recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While it is always sensible to look at a company's total liabilities, it is very reassuring that CNOOC has CN¥118.6b in net cash. And it also grew its EBIT by 15% over the last year. So we don't think CNOOC's use of debt is risky. 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. Case in point: We've spotted 2 warning signs for CNOOC you should be aware of, and 1 of them can't be ignored.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.