We Think Inner Mongolia Baotou Steel Union (SHSE:600010) Is Taking Some Risk With Its Debt

Warren Buffett famously said, '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. We note that Inner Mongolia Baotou Steel Union Co., Ltd. (SHSE:600010) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Inner Mongolia Baotou Steel Union

How Much Debt Does Inner Mongolia Baotou Steel Union Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Inner Mongolia Baotou Steel Union had CN¥50.4b of debt, an increase on CN¥42.2b, over one year. However, it does have CN¥8.16b in cash offsetting this, leading to net debt of about CN¥42.3b.

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¥66.4b due within 12 months and liabilities of CN¥24.9b due beyond that. Offsetting this, it had CN¥8.16b in cash and CN¥13.8b in receivables that were due within 12 months. So it has liabilities totalling CN¥69.3b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥64.9b, we think shareholders really should watch Inner Mongolia Baotou Steel Union's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 1.2 times and a disturbingly high net debt to EBITDA ratio of 6.8 hit our confidence in Inner Mongolia Baotou Steel Union like a one-two punch to the gut. The debt burden here is substantial. However, it should be some comfort for shareholders to recall that Inner Mongolia Baotou Steel Union actually grew its EBIT by a hefty 164%, over the last 12 months. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Inner Mongolia Baotou Steel Union recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

While Inner Mongolia Baotou Steel Union's interest cover has us nervous. To wit both its EBIT growth rate and conversion of EBIT to free cash flow were encouraging signs. We think that Inner Mongolia Baotou Steel Union's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Inner Mongolia Baotou Steel Union .

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.

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