Here's Why China Titans Energy Technology Group (HKG:2188) Can Manage Its Debt Responsibly

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. We can see that China Titans Energy Technology Group Co., Limited (HKG:2188) 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 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 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for China Titans Energy Technology Group

What Is China Titans Energy Technology Group's Debt?

You can click the graphic below for the historical numbers, but it shows that China Titans Energy Technology Group had CN¥163.8m of debt in June 2022, down from CN¥181.5m, one year before. However, because it has a cash reserve of CN¥73.1m, its net debt is less, at about CN¥90.7m.

A Look At China Titans Energy Technology Group's Liabilities

We can see from the most recent balance sheet that China Titans Energy Technology Group had liabilities of CN¥313.7m falling due within a year, and liabilities of CN¥77.7m due beyond that. Offsetting this, it had CN¥73.1m in cash and CN¥343.8m in receivables that were due within 12 months. So it can boast CN¥25.5m more liquid assets than total liabilities.

This surplus suggests that China Titans Energy Technology Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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.

China Titans Energy Technology Group's net debt is sitting at a very reasonable 2.1 times its EBITDA, while its EBIT covered its interest expense just 2.7 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. We also note that China Titans Energy Technology Group improved its EBIT from a last year's loss to a positive CN¥24m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China Titans Energy Technology Group will need earnings to service that debt. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. In the last year, China Titans Energy Technology Group's free cash flow amounted to 36% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

China Titans Energy Technology Group's interest cover was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we thought its level of total liabilities was a positive. When we consider all the factors mentioned above, we do feel a bit cautious about China Titans Energy Technology Group's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for China Titans Energy Technology Group (1 shouldn't be ignored!) that you should be aware of before investing here.

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.