Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Maanshan Iron & Steel Company Limited (HKG:323) makes use of debt. But the real question is whether this debt is making the company risky.
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Maanshan Iron & Steel's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 Maanshan Iron & Steel had CN¥18.0b of debt, an increase on CN¥16.5b, over one year. On the flip side, it has CN¥5.96b in cash leading to net debt of about CN¥12.1b.
How Healthy Is Maanshan Iron & Steel's Balance Sheet?
We can see from the most recent balance sheet that Maanshan Iron & Steel had liabilities of CN¥45.0b falling due within a year, and liabilities of CN¥7.66b due beyond that. Offsetting these obligations, it had cash of CN¥5.96b as well as receivables valued at CN¥5.53b due within 12 months. So it has liabilities totalling CN¥41.2b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the CN¥18.4b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Maanshan Iron & Steel would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Maanshan Iron & Steel'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.
Over 12 months, Maanshan Iron & Steel made a loss at the EBIT level, and saw its revenue drop to CN¥97b, which is a fall of 9.9%. That's not what we would hope to see.
Caveat Emptor
Importantly, Maanshan Iron & Steel had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable CN¥3.6b at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through CN¥2.6b in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. For riskier companies like Maanshan Iron & Steel I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
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.