Yahoo Finanza Is Zhengzhou Coal Mining Machinery Group (HKG:564) Using Too Much Debt?
The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Zhengzhou Coal Mining Machinery Group Company Limited (HKG:564) does use debt in its business. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Zhengzhou Coal Mining Machinery Group
What Is Zhengzhou Coal Mining Machinery Group's Net Debt?
The chart below, which you can click on for greater detail, shows that Zhengzhou Coal Mining Machinery Group had CN¥4.22b in debt in March 2020; about the same as the year before. But it also has CN¥5.66b in cash to offset that, meaning it has CN¥1.44b net cash.
How Healthy Is Zhengzhou Coal Mining Machinery Group's Balance Sheet?
We can see from the most recent balance sheet that Zhengzhou Coal Mining Machinery Group had liabilities of CN¥11.3b falling due within a year, and liabilities of CN¥4.21b due beyond that. Offsetting these obligations, it had cash of CN¥5.66b as well as receivables valued at CN¥8.75b due within 12 months. So it has liabilities totalling CN¥1.09b more than its cash and near-term receivables, combined.
Given Zhengzhou Coal Mining Machinery Group has a market capitalization of CN¥8.08b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Zhengzhou Coal Mining Machinery Group boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that Zhengzhou Coal Mining Machinery Group grew its EBIT by 14% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Zhengzhou Coal Mining Machinery Group 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Zhengzhou Coal Mining Machinery Group 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. Looking at the most recent three years, Zhengzhou Coal Mining Machinery Group recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Summing up
Although Zhengzhou Coal Mining Machinery Group'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¥1.44b. On top of that, it increased its EBIT by 14% in the last twelve months. So we are not troubled with Zhengzhou Coal Mining Machinery Group's debt use. 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. Be aware that Zhengzhou Coal Mining Machinery Group is showing 2 warning signs in our investment analysis , 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.
Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.
This article by Simply Wall St is general in nature. 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. Thank you for reading.
