We Think Chongqing Taiji Industry(Group)Ltd (SHSE:600129) Is Taking Some Risk With Its Debt

Warren Buffett famously said, '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 real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out our latest analysis for Chongqing Taiji Industry(Group)Ltd

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

The image below, which you can click on for greater detail, shows that at September 2024 Chongqing Taiji Industry(Group)Ltd had debt of CN¥4.66b, up from CN¥4.13b in one year. However, it does have CN¥842.1m in cash offsetting this, leading to net debt of about CN¥3.82b.

How Healthy 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¥9.21b due within 12 months, and liabilities of CN¥997.2m due beyond 12 months. Offsetting this, it had CN¥842.1m in cash and CN¥3.16b in receivables that were due within 12 months. So its liabilities total CN¥6.21b more than the combination of its cash and short-term receivables.

Chongqing Taiji Industry(Group)Ltd has a market capitalization of CN¥12.4b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. 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). 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).

Chongqing Taiji Industry(Group)Ltd has a debt to EBITDA ratio of 3.3 and its EBIT covered its interest expense 6.4 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Importantly, Chongqing Taiji Industry(Group)Ltd's EBIT fell a jaw-dropping 24% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Chongqing Taiji Industry(Group)Ltd's ability to maintain a healthy balance sheet going forward. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Chongqing Taiji Industry(Group)Ltd reported free cash flow worth 5.8% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Mulling over Chongqing Taiji Industry(Group)Ltd's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Chongqing Taiji Industry(Group)Ltd's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Chongqing Taiji Industry(Group)Ltd (including 1 which is a bit unpleasant) .

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.