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 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 note that CNOOC Energy Technology & Services Limited (SHSE:600968) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for CNOOC Energy Technology & Services
What Is CNOOC Energy Technology & Services's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2023 CNOOC Energy Technology & Services had debt of CN¥1.71b, up from CN¥504.5m in one year. However, it does have CN¥7.47b in cash offsetting this, leading to net cash of CN¥5.75b.
How Strong Is CNOOC Energy Technology & Services' Balance Sheet?
According to the last reported balance sheet, CNOOC Energy Technology & Services had liabilities of CN¥14.1b due within 12 months, and liabilities of CN¥2.95b due beyond 12 months. On the other hand, it had cash of CN¥7.47b and CN¥12.9b worth of receivables due within a year. So it actually has CN¥3.32b more liquid assets than total liabilities.
This short term liquidity is a sign that CNOOC Energy Technology & Services could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that CNOOC Energy Technology & Services has more cash than debt is arguably a good indication that it can manage its debt safely.
And we also note warmly that CNOOC Energy Technology & Services grew its EBIT by 11% last year, making its debt load easier to handle. 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 Energy Technology & Services can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. CNOOC Energy Technology & Services 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. During the last three years, CNOOC Energy Technology & Services generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd 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, you should keep in mind that CNOOC Energy Technology & Services has net cash of CN¥5.75b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.1b, being 92% of its EBIT. So we don't think CNOOC Energy Technology & Services'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. To that end, you should be aware of the 1 warning sign we've spotted with CNOOC Energy Technology & Services .
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.