China Tungsten And Hightech MaterialsLtd (SZSE:000657) Has A Somewhat Strained Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that China Tungsten And Hightech Materials Co.,Ltd (SZSE:000657) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 China Tungsten And Hightech MaterialsLtd

What Is China Tungsten And Hightech MaterialsLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 China Tungsten And Hightech MaterialsLtd had CN¥3.80b of debt, an increase on CN¥3.14b, over one year. However, it does have CN¥695.6m in cash offsetting this, leading to net debt of about CN¥3.11b.

How Healthy Is China Tungsten And Hightech MaterialsLtd's Balance Sheet?

According to the last reported balance sheet, China Tungsten And Hightech MaterialsLtd had liabilities of CN¥5.39b due within 12 months, and liabilities of CN¥1.92b due beyond 12 months. Offsetting these obligations, it had cash of CN¥695.6m as well as receivables valued at CN¥4.76b due within 12 months. So it has liabilities totalling CN¥1.85b more than its cash and near-term receivables, combined.

Of course, China Tungsten And Hightech MaterialsLtd has a market capitalization of CN¥14.3b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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

China Tungsten And Hightech MaterialsLtd has a debt to EBITDA ratio of 3.1 and its EBIT covered its interest expense 5.6 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Importantly, China Tungsten And Hightech MaterialsLtd's EBIT fell a jaw-dropping 21% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if China Tungsten And Hightech MaterialsLtd 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last three years, China Tungsten And Hightech MaterialsLtd actually recorded a cash outflow, overall. 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

To be frank both China Tungsten And Hightech MaterialsLtd's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. Having said that, its ability to handle its total liabilities isn't such a worry. Overall, we think it's fair to say that China Tungsten And Hightech MaterialsLtd has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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, we've discovered 3 warning signs for China Tungsten And Hightech MaterialsLtd (1 is concerning!) that you should be aware of before investing here.

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.