These 4 Measures Indicate That CITIC Resources Holdings (HKG:1205) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies CITIC Resources Holdings Limited (HKG:1205) makes use of debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out the opportunities and risks within the HK Trade Distributors industry.

What Is CITIC Resources Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that CITIC Resources Holdings had HK$3.33b of debt in June 2022, down from HK$3.73b, one year before. However, because it has a cash reserve of HK$2.49b, its net debt is less, at about HK$843.5m.

A Look At CITIC Resources Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that CITIC Resources Holdings had liabilities of HK$1.85b due within 12 months and liabilities of HK$4.05b due beyond that. Offsetting these obligations, it had cash of HK$2.49b as well as receivables valued at HK$588.2m due within 12 months. So it has liabilities totalling HK$2.83b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of HK$3.14b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

CITIC Resources Holdings's net debt is only 0.43 times its EBITDA. And its EBIT covers its interest expense a whopping 29.8 times over. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that CITIC Resources Holdings grew its EBIT by 538% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is CITIC Resources Holdings'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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last two years, CITIC Resources Holdings generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, CITIC Resources Holdings's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its level of total liabilities does undermine this impression a bit. Taking all this data into account, it seems to us that CITIC Resources Holdings takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. Be aware that CITIC Resources Holdings is showing 1 warning sign in our investment analysis , you should know about...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.