Is Inner Mongolia Baotou Steel Union (SHSE:600010) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Inner Mongolia Baotou Steel Union Co., Ltd. (SHSE:600010) does use debt in its business. 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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Inner Mongolia Baotou Steel Union

How Much Debt Does Inner Mongolia Baotou Steel Union Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Inner Mongolia Baotou Steel Union had debt of CN¥52.1b, up from CN¥48.1b in one year. On the flip side, it has CN¥10.5b in cash leading to net debt of about CN¥41.6b.

How Healthy Is Inner Mongolia Baotou Steel Union's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Inner Mongolia Baotou Steel Union had liabilities of CN¥69.8b due within 12 months and liabilities of CN¥23.6b due beyond that. Offsetting this, it had CN¥10.5b in cash and CN¥13.8b in receivables that were due within 12 months. So it has liabilities totalling CN¥69.1b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its very significant market capitalization of CN¥73.1b, so it does suggest shareholders should keep an eye on Inner Mongolia Baotou Steel Union's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

Inner Mongolia Baotou Steel Union shareholders face the double whammy of a high net debt to EBITDA ratio (6.8), and fairly weak interest coverage, since EBIT is just 1.1 times the interest expense. This means we'd consider it to have a heavy debt load. The silver lining is that Inner Mongolia Baotou Steel Union grew its EBIT by 147% last year, which nourishing like the idealism of youth. If it can keep walking that path it will be in a position to shed its debt with relative ease. 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 Inner Mongolia Baotou Steel Union'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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Inner Mongolia Baotou Steel Union produced sturdy free cash flow equating to 64% 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

Inner Mongolia Baotou Steel Union's interest cover and net debt to EBITDA definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Inner Mongolia Baotou Steel Union is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. Case in point: We've spotted 2 warning signs for Inner Mongolia Baotou Steel Union you should be aware of, and 1 of them shouldn't be ignored.

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.