Does China Vanadium Titano-Magnetite Mining (HKG:893) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies China Vanadium Titano-Magnetite Mining Company Limited (HKG:893) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for China Vanadium Titano-Magnetite Mining

How Much Debt Does China Vanadium Titano-Magnetite Mining Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 China Vanadium Titano-Magnetite Mining had CN¥92.2m of debt, an increase on CN¥87.6m, over one year. On the flip side, it has CN¥4.07m in cash leading to net debt of about CN¥88.1m.

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

According to the last reported balance sheet, China Vanadium Titano-Magnetite Mining had liabilities of CN¥226.1m due within 12 months, and liabilities of CN¥123.1m due beyond 12 months. Offsetting these obligations, it had cash of CN¥4.07m as well as receivables valued at CN¥11.4m due within 12 months. So it has liabilities totalling CN¥333.7m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥122.0m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, China Vanadium Titano-Magnetite Mining would likely require a major re-capitalisation if it had to pay its creditors today.

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

While we wouldn't worry about China Vanadium Titano-Magnetite Mining's net debt to EBITDA ratio of 3.7, we think its super-low interest cover of 1.8 times is a sign of high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. However, it should be some comfort for shareholders to recall that China Vanadium Titano-Magnetite Mining actually grew its EBIT by a hefty 11,236%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China Vanadium Titano-Magnetite Mining 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, China Vanadium Titano-Magnetite Mining recorded free cash flow of 43% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both China Vanadium Titano-Magnetite Mining's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. Looking at the bigger picture, it seems clear to us that China Vanadium Titano-Magnetite Mining's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with China Vanadium Titano-Magnetite Mining , and understanding them should be part of your investment process.

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.