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.' 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. As with many other companies Lingyuan Iron & Steel Co., Ltd. (SHSE:600231) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

Check out our latest analysis for Lingyuan Iron & Steel

How Much Debt Does Lingyuan Iron & Steel Carry?

As you can see below, at the end of September 2024, Lingyuan Iron & Steel had CN¥2.85b of debt, up from CN¥1.91b a year ago. Click the image for more detail. However, it also had CN¥1.83b in cash, and so its net debt is CN¥1.02b.

A Look At Lingyuan Iron & Steel's Liabilities

Zooming in on the latest balance sheet data, we can see that Lingyuan Iron & Steel had liabilities of CN¥6.77b due within 12 months and liabilities of CN¥2.51b due beyond that. Offsetting these obligations, it had cash of CN¥1.83b as well as receivables valued at CN¥280.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥7.17b.

Given this deficit is actually higher than the company's market capitalization of CN¥6.13b, we think shareholders really should watch Lingyuan Iron & Steel'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. There's no doubt that we learn most about debt from the balance sheet. But it is Lingyuan Iron & Steel's earnings that will influence how the balance sheet holds up in the future. 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 4.8%, to CN¥19b. We would much prefer see growth.

Caveat Emptor

Importantly, Lingyuan Iron & Steel had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping CN¥1.9b. 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. It's fair to say the loss of CN¥1.8b didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. 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. For example, we've discovered 1 warning sign for Lingyuan Iron & Steel that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.