Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies CITIC Heavy Industries Co., Ltd. (SHSE:601608) 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does CITIC Heavy Industries Carry?

The image below, which you can click on for greater detail, shows that CITIC Heavy Industries had debt of CN¥2.32b at the end of September 2023, a reduction from CN¥4.47b over a year. However, because it has a cash reserve of CN¥999.7m, its net debt is less, at about CN¥1.32b.

A Look At CITIC Heavy Industries' Liabilities

The latest balance sheet data shows that CITIC Heavy Industries had liabilities of CN¥7.95b due within a year, and liabilities of CN¥1.97b falling due after that. Offsetting this, it had CN¥999.7m in cash and CN¥4.50b in receivables that were due within 12 months. So it has liabilities totalling CN¥4.42b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since CITIC Heavy Industries has a market capitalization of CN¥18.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since CITIC Heavy Industries will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year CITIC Heavy Industries wasn't profitable at an EBIT level, but managed to grow its revenue by 2.4%, to CN¥9.0b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months CITIC Heavy Industries produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥87m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Surprisingly, we note that it actually reported positive free cash flow of CN¥986m and a profit of CN¥219m. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for CITIC Heavy Industries you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.