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Here's Why China Machinery Engineering (HKG:1829) Has A Meaningful Debt Burden

Simply Wall St

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. 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. Importantly, China Machinery Engineering Corporation (HKG:1829) does carry debt. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for China Machinery Engineering

What Is China Machinery Engineering's Debt?

The image below, which you can click on for greater detail, shows that China Machinery Engineering had debt of CN¥642.7m at the end of June 2019, a reduction from CN¥1.20b over a year. But it also has CN¥22.1b in cash to offset that, meaning it has CN¥21.5b net cash.

SEHK:1829 Historical Debt, September 24th 2019

How Healthy Is China Machinery Engineering's Balance Sheet?

According to the last reported balance sheet, China Machinery Engineering had liabilities of CN¥36.4b due within 12 months, and liabilities of CN¥1.57b due beyond 12 months. On the other hand, it had cash of CN¥22.1b and CN¥16.7b worth of receivables due within a year. So it actually has CN¥848.6m more liquid assets than total liabilities.

This short term liquidity is a sign that China Machinery Engineering could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, China Machinery Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that China Machinery Engineering's load is not too heavy, because its EBIT was down 33% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if China Machinery Engineering 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. China Machinery Engineering 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 Machinery Engineering saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that China Machinery Engineering has net cash of CN¥21.5b, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about China Machinery Engineering's balance sheet. Given China Machinery Engineering has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.