Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that Aluminum Corporation of China Limited (HKG:2600) uses debt in his business. But the real question is whether this debt makes the business risky.
What risk does debt carry?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, 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 at a low price, thereby permanently diluting shareholders. Of course, many companies use debt to finance their growth, without any negative consequences. When we look at debt levels, we first consider cash and debt levels, together.
Check out our latest analysis for Aluminum Corporation of China
What is the debt of Aluminum Corporation of China?
You can click on the graph below for historical figures, but it shows that Aluminum Corporation of China had 81.3 billion Canadian yen in debt in September 2021, compared to 86.9 billion Canadian yen a year before. However, he also had 18.6 billion yen in cash, so his net debt is 62.7 billion yen.
A look at the liabilities of Aluminum Corporation of China
According to the latest published balance sheet, Aluminum Corporation of China had liabilities of 53.2 billion Canadian yen due within 12 months and liabilities of 65.5 billion Canadian yen due beyond 12 months. In return for these bonds, it had cash of 18.6 billion Canadian yen as well as receivables valued at 13.9 billion national yen due within 12 months. Thus, its liabilities total 86.2 billion Canadian yen more than the combination of its cash and short-term receivables.
This deficit is considerable compared to its very large market capitalization of 108.3 billion Canadian yen, so it suggests that shareholders monitor the use of debt by the Aluminum Corporation of China. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Aluminum Corporation of China has a debt to EBITDA ratio of 2.6 and its EBIT covered its interest expense 4.6 times. This suggests that while debt levels are significant, we will refrain from labeling them as problematic. Fortunately, Aluminum Corporation of China is growing its EBIT faster than former Australian Prime Minister Bob Hawke shot down a meter glass, with a 204% gain over the last twelve months. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Aluminum Corporation of China can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Fortunately for all shareholders, Aluminum Corporation of China has actually produced more free cash flow than EBIT for the past three years. This kind of high cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our point of view
Fortunately, Aluminum Corporation of China’s impressive EBIT to free cash flow conversion means it has the upper hand on its debt. But, on a darker note, we’re a bit concerned about his total passive level. All in all, it looks like Aluminum Corporation of China can comfortably manage its current level of debt. On the plus side, this leverage can increase shareholder returns, but the potential downside is greater risk of loss, so it’s worth keeping an eye on the balance sheet. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 2 warning signs for Aluminum Corporation of China you should be aware.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.