Here's Why CITIC Heavy Industries (SHSE:601608) Can Afford Some Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 can see that CITIC Heavy Industries Co., Ltd. (SHSE:601608) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for CITIC Heavy Industries

How Much Debt Does CITIC Heavy Industries Carry?

As you can see below, CITIC Heavy Industries had CN¥2.32b of debt at September 2023, down from CN¥4.47b a year prior. On the flip side, it has CN¥999.7m in cash leading to net debt of about CN¥1.32b.

How Healthy Is CITIC Heavy Industries' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CITIC Heavy Industries had liabilities of CN¥7.95b due within 12 months and liabilities of CN¥1.97b due beyond that. Offsetting these obligations, it had cash of CN¥999.7m as well as receivables valued at CN¥4.50b due within 12 months. So its liabilities total CN¥4.42b more than the combination of its cash and short-term receivables.

CITIC Heavy Industries has a market capitalization of CN¥18.1b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since CITIC Heavy Industries will need earnings to service that debt. 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.

Over 12 months, CITIC Heavy Industries reported revenue of CN¥9.0b, which is a gain of 2.4%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, CITIC Heavy Industries had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥87m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Surprisingly, we note that it actually reported positive free cash flow of CN¥986m and a profit of CN¥219m. So one might argue that there's still a chance it can get things on the right track. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for CITIC Heavy Industries that you should be aware of.

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.

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