Is Chongqing Taiji Industry(Group)Ltd (SHSE:600129) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Chongqing Taiji Industry(Group) Co.,Ltd (SHSE:600129) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Chongqing Taiji Industry(Group)Ltd

What Is Chongqing Taiji Industry(Group)Ltd's Net Debt?

As you can see below, Chongqing Taiji Industry(Group)Ltd had CN¥4.11b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥1.61b in cash, and so its net debt is CN¥2.49b.

How Strong Is Chongqing Taiji Industry(Group)Ltd's Balance Sheet?

According to the last reported balance sheet, Chongqing Taiji Industry(Group)Ltd had liabilities of CN¥10.3b due within 12 months, and liabilities of CN¥1.05b due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.61b as well as receivables valued at CN¥3.41b due within 12 months. So its liabilities total CN¥6.36b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Chongqing Taiji Industry(Group)Ltd has a market capitalization of CN¥16.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Chongqing Taiji Industry(Group)Ltd's net debt of 1.8 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 8.1 times its interest expenses harmonizes with that theme. We note that Chongqing Taiji Industry(Group)Ltd grew its EBIT by 28% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Chongqing Taiji Industry(Group)Ltd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last two years, Chongqing Taiji Industry(Group)Ltd's free cash flow amounted to 47% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that Chongqing Taiji Industry(Group)Ltd's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. And we also thought its interest cover was a positive. All these things considered, it appears that Chongqing Taiji Industry(Group)Ltd can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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 instance, we've identified 2 warning signs for Chongqing Taiji Industry(Group)Ltd (1 is a bit concerning) you should be aware of.

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.

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