Is Baoji Titanium Industry (SHSE:600456) Using Too Much Debt?

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.' 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 Baoji Titanium Industry Co., Ltd. (SHSE:600456) makes use of debt. But is this debt a concern to shareholders?

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 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Baoji Titanium Industry

What Is Baoji Titanium Industry's Debt?

The chart below, which you can click on for greater detail, shows that Baoji Titanium Industry had CN¥2.27b in debt in September 2024; about the same as the year before. On the flip side, it has CN¥1.24b in cash leading to net debt of about CN¥1.03b.

How Healthy Is Baoji Titanium Industry's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Baoji Titanium Industry had liabilities of CN¥5.15b due within 12 months and liabilities of CN¥800.2m due beyond that. On the other hand, it had cash of CN¥1.24b and CN¥4.46b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥253.3m.

Having regard to Baoji Titanium Industry's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥14.6b company is short on cash, but still worth keeping an eye on the balance sheet.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Baoji Titanium Industry has a low net debt to EBITDA ratio of only 1.1. And its EBIT covers its interest expense a whopping 12.8 times over. So we're pretty relaxed about its super-conservative use of debt. The modesty of its debt load may become crucial for Baoji Titanium Industry if management cannot prevent a repeat of the 29% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Baoji Titanium Industry can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Baoji Titanium Industry recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Neither Baoji Titanium Industry's ability to grow its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. Looking at all the angles mentioned above, it does seem to us that Baoji Titanium Industry is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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 - Baoji Titanium Industry has 2 warning signs we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.