Is Baoji Titanium Industry (SHSE:600456) Using Too Much 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 note that Baoji Titanium Industry Co., Ltd. (SHSE:600456) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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

How Much Debt Does Baoji Titanium Industry Carry?

As you can see below, Baoji Titanium Industry had CN¥2.27b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥1.24b in cash, and so its net debt is CN¥1.03b.

How Healthy Is Baoji Titanium Industry's Balance Sheet?

The latest balance sheet data shows that Baoji Titanium Industry had liabilities of CN¥5.15b due within a year, and liabilities of CN¥800.2m falling due after that. On the other hand, it had cash of CN¥1.24b and CN¥4.46b worth of receivables due within a year. So it has liabilities totalling CN¥253.3m more than its cash and near-term receivables, combined.

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¥13.1b company is short on cash, but still worth keeping an eye on the balance sheet.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

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. In fact Baoji Titanium Industry's saving grace is its low debt levels, because its EBIT has tanked 29% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Baoji Titanium Industry's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, Baoji Titanium Industry actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

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. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. 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, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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

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.