Is Lingyuan Iron & Steel (SHSE:600231) Using Debt Sensibly?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Lingyuan Iron & Steel Co., Ltd. (SHSE:600231) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Lingyuan Iron & Steel

How Much Debt Does Lingyuan Iron & Steel Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Lingyuan Iron & Steel had debt of CN¥2.46b, up from CN¥2.06b in one year. However, because it has a cash reserve of CN¥1.67b, its net debt is less, at about CN¥793.2m.

How Strong Is Lingyuan Iron & Steel's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Lingyuan Iron & Steel had liabilities of CN¥6.33b due within 12 months and liabilities of CN¥1.81b due beyond that. Offsetting these obligations, it had cash of CN¥1.67b as well as receivables valued at CN¥291.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.18b.

When you consider that this deficiency exceeds the company's CN¥4.31b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Lingyuan Iron & 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 Lingyuan Iron & Steel had a loss before interest and tax, and actually shrunk its revenue by 5.2%, to CN¥20b. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months Lingyuan Iron & Steel produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping CN¥1.3b. Considering that alongside the liabilities mentioned above make us nervous 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¥1.0b. 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 Lingyuan Iron & Steel you should be aware of.

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.