CITIC Heavy Industries (SHSE:601608) Has A Pretty Healthy Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies CITIC Heavy Industries Co., Ltd. (SHSE:601608) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 CITIC Heavy Industries

How Much Debt Does CITIC Heavy Industries Carry?

The image below, which you can click on for greater detail, shows that CITIC Heavy Industries had debt of CN¥2.12b at the end of September 2024, a reduction from CN¥2.32b over a year. However, it does have CN¥1.55b in cash offsetting this, leading to net debt of about CN¥572.7m.

How Healthy Is CITIC Heavy Industries' Balance Sheet?

We can see from the most recent balance sheet that CITIC Heavy Industries had liabilities of CN¥8.05b falling due within a year, and liabilities of CN¥1.71b due beyond that. Offsetting this, it had CN¥1.55b in cash and CN¥4.56b in receivables that were due within 12 months. So it has liabilities totalling CN¥3.65b more than its cash and near-term receivables, combined.

Since publicly traded CITIC Heavy Industries shares are worth a total of CN¥19.0b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

CITIC Heavy Industries has a low debt to EBITDA ratio of only 0.98. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. Although CITIC Heavy Industries made a loss at the EBIT level, last year, it was also good to see that it generated CN¥317m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is CITIC Heavy Industries's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, CITIC Heavy Industries actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that CITIC Heavy Industries's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Taking all this data into account, it seems to us that CITIC Heavy Industries takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. For example - CITIC Heavy Industries has 2 warning signs we think you should be aware of.

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.