Here's Why Tongyi Carbon Neutral Technology (Xinjiang) (SHSE:600506) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Tongyi Carbon Neutral Technology (Xinjiang) Co., Ltd (SHSE:600506) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Tongyi Carbon Neutral Technology (Xinjiang)

How Much Debt Does Tongyi Carbon Neutral Technology (Xinjiang) Carry?

As you can see below, Tongyi Carbon Neutral Technology (Xinjiang) had CN¥1.04b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥141.2m in cash offsetting this, leading to net debt of about CN¥898.5m.

A Look At Tongyi Carbon Neutral Technology (Xinjiang)'s Liabilities

The latest balance sheet data shows that Tongyi Carbon Neutral Technology (Xinjiang) had liabilities of CN¥1.14b due within a year, and liabilities of CN¥527.4m falling due after that. Offsetting this, it had CN¥141.2m in cash and CN¥462.9m in receivables that were due within 12 months. So its liabilities total CN¥1.06b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Tongyi Carbon Neutral Technology (Xinjiang) is worth CN¥4.06b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Tongyi Carbon Neutral Technology (Xinjiang) shareholders face the double whammy of a high net debt to EBITDA ratio (8.4), and fairly weak interest coverage, since EBIT is just 1.2 times the interest expense. The debt burden here is substantial. One redeeming factor for Tongyi Carbon Neutral Technology (Xinjiang) is that it turned last year's EBIT loss into a gain of CN¥80m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Tongyi Carbon Neutral Technology (Xinjiang)'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 company can only pay off debt with cold hard cash, not accounting profits. 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, Tongyi Carbon Neutral Technology (Xinjiang) actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Tongyi Carbon Neutral Technology (Xinjiang)'s interest cover was a real negative on this analysis, as was its net debt to EBITDA. But like a ballerina ending on a perfect pirouette, it has not trouble converting EBIT to free cash flow. When we consider all the factors mentioned above, we do feel a bit cautious about Tongyi Carbon Neutral Technology (Xinjiang)'s use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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 3 warning signs for Tongyi Carbon Neutral Technology (Xinjiang) (2 are a bit concerning) 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.