Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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, SINOPEC Engineering (Group) Co., Ltd. (HKG:2386) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. 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.

What Is SINOPEC Engineering (Group)'s Net Debt?

You can click the graphic below for the historical numbers, but it shows that SINOPEC Engineering (Group) had CN¥129.2m of debt in June 2024, down from CN¥154.2m, one year before. However, its balance sheet shows it holds CN¥20.8b in cash, so it actually has CN¥20.7b net cash.

A Look At SINOPEC Engineering (Group)'s Liabilities

According to the last reported balance sheet, SINOPEC Engineering (Group) had liabilities of CN¥48.0b due within 12 months, and liabilities of CN¥1.95b due beyond 12 months. On the other hand, it had cash of CN¥20.8b and CN¥41.2b worth of receivables due within a year. So it can boast CN¥12.0b more liquid assets than total liabilities.

This luscious liquidity implies that SINOPEC Engineering (Group)'s balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, SINOPEC Engineering (Group) boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, SINOPEC Engineering (Group) grew its EBIT by 35% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine SINOPEC Engineering (Group)'s ability to maintain a healthy balance sheet going forward. 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. While SINOPEC Engineering (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. Over the last three years, SINOPEC Engineering (Group) actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case SINOPEC Engineering (Group) has CN¥20.7b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of -CN¥1.1b, being 183% of its EBIT. At the end of the day we're not concerned about SINOPEC Engineering (Group)'s debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for SINOPEC Engineering (Group) (of which 1 makes us a bit uncomfortable!) you should know about.

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.