Taiyuan Heavy Industry (SHSE:600169) Has No Shortage Of Debt

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.' 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 Taiyuan Heavy Industry Co., Ltd. (SHSE:600169) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Taiyuan Heavy Industry

What Is Taiyuan Heavy Industry's Net Debt?

As you can see below, Taiyuan Heavy Industry had CN¥15.2b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥2.08b in cash offsetting this, leading to net debt of about CN¥13.1b.

How Healthy Is Taiyuan Heavy Industry's Balance Sheet?

The latest balance sheet data shows that Taiyuan Heavy Industry had liabilities of CN¥17.7b due within a year, and liabilities of CN¥8.43b falling due after that. Offsetting this, it had CN¥2.08b in cash and CN¥8.76b in receivables that were due within 12 months. So its liabilities total CN¥15.2b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥6.55b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Taiyuan Heavy Industry would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.6 times and a disturbingly high net debt to EBITDA ratio of 15.0 hit our confidence in Taiyuan Heavy Industry like a one-two punch to the gut. The debt burden here is substantial. Another concern for investors might be that Taiyuan Heavy Industry's EBIT fell 17% in the last year. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. There's no doubt that we learn most about debt from the balance sheet. But it is Taiyuan Heavy Industry's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Taiyuan Heavy Industry burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Taiyuan Heavy Industry's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its interest cover also fails to instill confidence. Considering everything we've mentioned above, it's fair to say that Taiyuan Heavy Industry is carrying heavy debt load. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. 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. For example Taiyuan Heavy Industry has 2 warning signs (and 1 which is concerning) we think you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com