These 4 Measures Indicate That Xiamen TungstenLtd (SHSE:600549) Is Using Debt Reasonably Well

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.' 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 Xiamen Tungsten Co.,Ltd. (SHSE:600549) 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Xiamen TungstenLtd

How Much Debt Does Xiamen TungstenLtd Carry?

The image below, which you can click on for greater detail, shows that Xiamen TungstenLtd had debt of CN¥12.1b at the end of September 2024, a reduction from CN¥13.5b over a year. However, because it has a cash reserve of CN¥3.98b, its net debt is less, at about CN¥8.10b.

How Healthy Is Xiamen TungstenLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Xiamen TungstenLtd had liabilities of CN¥13.7b due within 12 months and liabilities of CN¥7.48b due beyond that. Offsetting these obligations, it had cash of CN¥3.98b as well as receivables valued at CN¥7.75b due within 12 months. So it has liabilities totalling CN¥9.47b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Xiamen TungstenLtd has a market capitalization of CN¥31.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Xiamen TungstenLtd's net debt to EBITDA ratio of about 1.9 suggests only moderate use of debt. And its strong interest cover of 33.4 times, makes us even more comfortable. Xiamen TungstenLtd grew its EBIT by 6.2% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. 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 Xiamen TungstenLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Xiamen TungstenLtd 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

When it comes to the balance sheet, the standout positive for Xiamen TungstenLtd was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. In particular, conversion of EBIT to free cash flow gives us cold feet. Looking at all this data makes us feel a little cautious about Xiamen TungstenLtd's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Xiamen TungstenLtd that you should be aware of before investing here.

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.