Is Shandong Iron and Steel (SHSE:600022) Using Debt In A Risky Way?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Shandong Iron and Steel Company Ltd. (SHSE:600022) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Shandong Iron and Steel

How Much Debt Does Shandong Iron and Steel Carry?

The chart below, which you can click on for greater detail, shows that Shandong Iron and Steel had CN¥12.4b in debt in September 2024; about the same as the year before. However, it does have CN¥6.84b in cash offsetting this, leading to net debt of about CN¥5.58b.

How Healthy Is Shandong Iron and Steel's Balance Sheet?

The latest balance sheet data shows that Shandong Iron and Steel had liabilities of CN¥32.0b due within a year, and liabilities of CN¥5.79b falling due after that. Offsetting these obligations, it had cash of CN¥6.84b as well as receivables valued at CN¥1.78b due within 12 months. So it has liabilities totalling CN¥29.2b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥17.7b 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'd watch its balance sheet closely, without a doubt. After all, Shandong Iron and Steel would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shandong Iron and Steel will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Shandong Iron and Steel had a loss before interest and tax, and actually shrunk its revenue by 8.1%, to CN¥86b. We would much prefer see growth.

Caveat Emptor

Importantly, Shandong Iron and Steel had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥1.2b at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of CN¥1.5b. And until that time we think this is a risky stock. 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 1 warning sign for Shandong Iron and Steel you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.