We Think Guangzhou Tinci Materials Technology (SZSE:002709) Is Taking Some Risk With Its Debt

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. We can see that Guangzhou Tinci Materials Technology Co., Ltd. (SZSE:002709) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Guangzhou Tinci Materials Technology

How Much Debt Does Guangzhou Tinci Materials Technology Carry?

As you can see below, at the end of September 2024, Guangzhou Tinci Materials Technology had CN¥6.24b of debt, up from CN¥5.91b a year ago. Click the image for more detail. On the flip side, it has CN¥1.58b in cash leading to net debt of about CN¥4.66b.

How Strong Is Guangzhou Tinci Materials Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guangzhou Tinci Materials Technology had liabilities of CN¥6.01b due within 12 months and liabilities of CN¥4.59b due beyond that. Offsetting these obligations, it had cash of CN¥1.58b as well as receivables valued at CN¥5.24b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.78b.

Of course, Guangzhou Tinci Materials Technology has a market capitalization of CN¥42.7b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Guangzhou Tinci Materials Technology's debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 4.8 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Shareholders should be aware that Guangzhou Tinci Materials Technology's EBIT was down 81% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Guangzhou Tinci Materials Technology 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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Guangzhou Tinci Materials Technology barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Our View

Mulling over Guangzhou Tinci Materials Technology's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least it's pretty decent at staying on top of its total liabilities; that's encouraging. Once we consider all the factors above, together, it seems to us that Guangzhou Tinci Materials Technology's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Guangzhou Tinci Materials Technology (1 shouldn't be ignored) you should be aware of.

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.