Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Tianshan Aluminum Group Co.,Ltd (SZSE:002532) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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.

What Is Tianshan Aluminum GroupLtd's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Tianshan Aluminum GroupLtd had debt of CN¥21.2b, up from CN¥16.1b in one year. On the flip side, it has CN¥7.95b in cash leading to net debt of about CN¥13.2b.

How Healthy Is Tianshan Aluminum GroupLtd's Balance Sheet?

According to the last reported balance sheet, Tianshan Aluminum GroupLtd had liabilities of CN¥24.0b due within 12 months, and liabilities of CN¥8.08b due beyond 12 months. On the other hand, it had cash of CN¥7.95b and CN¥1.44b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥22.7b.

This deficit is considerable relative to its market capitalization of CN¥35.0b, so it does suggest shareholders should keep an eye on Tianshan Aluminum GroupLtd's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Tianshan Aluminum GroupLtd has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 4.5 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably Tianshan Aluminum GroupLtd's EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Tianshan Aluminum GroupLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Tianshan Aluminum GroupLtd's free cash flow amounted to 38% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Both Tianshan Aluminum GroupLtd's level of total liabilities and its net debt to EBITDA were discouraging. At least its EBIT growth rate gives us reason to be optimistic. When we consider all the factors discussed, it seems to us that Tianshan Aluminum GroupLtd is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Tianshan Aluminum GroupLtd .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.