China Vanadium Titano-Magnetite Mining (HKG:893) Use Of Debt Could Be Considered Risky

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 China Vanadium Titano-Magnetite Mining Company Limited (HKG:893) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for China Vanadium Titano-Magnetite Mining

What Is China Vanadium Titano-Magnetite Mining's Debt?

As you can see below, China Vanadium Titano-Magnetite Mining had CN¥97.0m of debt, at December 2022, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥9.36m in cash, and so its net debt is CN¥87.7m.

How Healthy Is China Vanadium Titano-Magnetite Mining's Balance Sheet?

The latest balance sheet data shows that China Vanadium Titano-Magnetite Mining had liabilities of CN¥231.9m due within a year, and liabilities of CN¥35.5m falling due after that. Offsetting this, it had CN¥9.36m in cash and CN¥211.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥46.8m.

While this might seem like a lot, it is not so bad since China Vanadium Titano-Magnetite Mining has a market capitalization of CN¥134.7m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.44 times and a disturbingly high net debt to EBITDA ratio of 7.1 hit our confidence in China Vanadium Titano-Magnetite Mining like a one-two punch to the gut. The debt burden here is substantial. Worse, China Vanadium Titano-Magnetite Mining's EBIT was down 65% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But it is China Vanadium Titano-Magnetite Mining's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, China Vanadium Titano-Magnetite Mining saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both China Vanadium Titano-Magnetite Mining's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least its level of total liabilities is not so bad. After considering the datapoints discussed, we think China Vanadium Titano-Magnetite Mining has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. We've identified 1 warning sign with China Vanadium Titano-Magnetite Mining , and understanding them should be part of your investment process.

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.