Is Anhui Truchum Advanced Materials and Technology (SZSE:002171) Using Too Much Debt?

Warren Buffett famously said, '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. We can see that Anhui Truchum Advanced Materials and Technology Co., Ltd. (SZSE:002171) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Anhui Truchum Advanced Materials and Technology

What Is Anhui Truchum Advanced Materials and Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Anhui Truchum Advanced Materials and Technology had CN¥10.1b of debt, an increase on CN¥7.84b, over one year. However, it does have CN¥3.28b in cash offsetting this, leading to net debt of about CN¥6.77b.

How Strong Is Anhui Truchum Advanced Materials and Technology's Balance Sheet?

According to the last reported balance sheet, Anhui Truchum Advanced Materials and Technology had liabilities of CN¥9.92b due within 12 months, and liabilities of CN¥2.71b due beyond 12 months. Offsetting these obligations, it had cash of CN¥3.28b as well as receivables valued at CN¥4.99b due within 12 months. So it has liabilities totalling CN¥4.36b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Anhui Truchum Advanced Materials and Technology has a market capitalization of CN¥11.2b, 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 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.

Weak interest cover of 1.9 times and a disturbingly high net debt to EBITDA ratio of 12.1 hit our confidence in Anhui Truchum Advanced Materials and Technology like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Anhui Truchum Advanced Materials and Technology saw its EBIT tank 32% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Anhui Truchum Advanced Materials and Technology's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Anhui Truchum Advanced Materials and Technology burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Anhui Truchum Advanced Materials and Technology's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least its level of total liabilities is not so bad. After considering the datapoints discussed, we think Anhui Truchum Advanced Materials and Technology has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. Be aware that Anhui Truchum Advanced Materials and Technology is showing 4 warning signs in our investment analysis , and 2 of those are a bit unpleasant...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.