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. Importantly, Chongqing Taiji Industry(Group) Co.,Ltd (SHSE:600129) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Chongqing Taiji Industry(Group)Ltd Carry?
You can click the graphic below for the historical numbers, but it shows that Chongqing Taiji Industry(Group)Ltd had CN¥4.08b of debt in December 2023, down from CN¥4.44b, one year before. However, it also had CN¥2.10b in cash, and so its net debt is CN¥1.98b.
How Healthy Is Chongqing Taiji Industry(Group)Ltd's Balance Sheet?
We can see from the most recent balance sheet that Chongqing Taiji Industry(Group)Ltd had liabilities of CN¥9.55b falling due within a year, and liabilities of CN¥1.12b due beyond that. On the other hand, it had cash of CN¥2.10b and CN¥2.50b worth of receivables due within a year. So its liabilities total CN¥6.07b more than the combination of its cash and short-term receivables.
Chongqing Taiji Industry(Group)Ltd has a market capitalization of CN¥18.2b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
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.
Chongqing Taiji Industry(Group)Ltd has net debt of just 1.4 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 8.3 times the interest expense over the last year. On top of that, Chongqing Taiji Industry(Group)Ltd grew its EBIT by 68% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Chongqing Taiji Industry(Group)Ltd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
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. During the last two years, Chongqing Taiji Industry(Group)Ltd produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
Chongqing Taiji Industry(Group)Ltd's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And its conversion of EBIT to free cash flow is good too. Taking all this data into account, it seems to us that Chongqing Taiji Industry(Group)Ltd takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Chongqing Taiji Industry(Group)Ltd (at least 1 which is a bit concerning) , 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.