Is China Vanadium Titano-Magnetite Mining (HKG:893) Using Too Much Debt?

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.' 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. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

Our analysis indicates that 893 is potentially overvalued!

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

The image below, which you can click on for greater detail, shows that China Vanadium Titano-Magnetite Mining had debt of CN¥87.6m at the end of June 2022, a reduction from CN¥91.9m over a year. On the flip side, it has CN¥3.75m in cash leading to net debt of about CN¥83.9m.

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¥216.4m due within 12 months, and liabilities of CN¥23.4m due beyond 12 months. Offsetting these obligations, it had cash of CN¥3.75m as well as receivables valued at CN¥222.2m due within 12 months. So its liabilities total CN¥13.9m more than the combination of its cash and short-term receivables.

Of course, China Vanadium Titano-Magnetite Mining has a market capitalization of CN¥211.3m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

China Vanadium Titano-Magnetite Mining shareholders face the double whammy of a high net debt to EBITDA ratio (10.1), and fairly weak interest coverage, since EBIT is just 0.02 times the interest expense. The debt burden here is substantial. Even worse, China Vanadium Titano-Magnetite Mining saw its EBIT tank 100% over the last 12 months. 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. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, China Vanadium Titano-Magnetite Mining burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, China Vanadium Titano-Magnetite Mining's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at staying on top of its total liabilities; that's encouraging. Overall, it seems to us that China Vanadium Titano-Magnetite Mining's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. For example - China Vanadium Titano-Magnetite Mining has 1 warning sign we think you should be aware of.

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.