These 4 Measures Indicate That CNNC Hua Yuan Titanium Dioxide (SZSE:002145) 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.' 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 CNNC Hua Yuan Titanium Dioxide Co., Ltd (SZSE:002145) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for CNNC Hua Yuan Titanium Dioxide

How Much Debt Does CNNC Hua Yuan Titanium Dioxide Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 CNNC Hua Yuan Titanium Dioxide had CN¥3.23b of debt, an increase on CN¥1.70b, over one year. But on the other hand it also has CN¥8.93b in cash, leading to a CN¥5.70b net cash position.

A Look At CNNC Hua Yuan Titanium Dioxide's Liabilities

The latest balance sheet data shows that CNNC Hua Yuan Titanium Dioxide had liabilities of CN¥4.74b due within a year, and liabilities of CN¥1.24b falling due after that. On the other hand, it had cash of CN¥8.93b and CN¥1.21b worth of receivables due within a year. So it can boast CN¥4.16b more liquid assets than total liabilities.

This excess liquidity suggests that CNNC Hua Yuan Titanium Dioxide is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, CNNC Hua Yuan Titanium Dioxide boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact CNNC Hua Yuan Titanium Dioxide's saving grace is its low debt levels, because its EBIT has tanked 82% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is CNNC Hua Yuan Titanium Dioxide'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While CNNC Hua Yuan Titanium Dioxide has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Considering the last three years, CNNC Hua Yuan Titanium Dioxide 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.

Summing Up

While it is always sensible to investigate a company's debt, in this case CNNC Hua Yuan Titanium Dioxide has CN¥5.70b in net cash and a decent-looking balance sheet. So we are not troubled with CNNC Hua Yuan Titanium Dioxide's debt use. 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. We've identified 3 warning signs with CNNC Hua Yuan Titanium Dioxide (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.