Is Fushun Special SteelLTD (SHSE:600399) 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 note that Fushun Special Steel Co.,LTD. (SHSE:600399) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Fushun Special SteelLTD

What Is Fushun Special SteelLTD's Debt?

As you can see below, at the end of June 2024, Fushun Special SteelLTD had CN¥3.07b of debt, up from CN¥2.70b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥1.40b, its net debt is less, at about CN¥1.67b.

How Strong Is Fushun Special SteelLTD's Balance Sheet?

The latest balance sheet data shows that Fushun Special SteelLTD had liabilities of CN¥3.84b due within a year, and liabilities of CN¥2.36b falling due after that. Offsetting these obligations, it had cash of CN¥1.40b as well as receivables valued at CN¥1.86b due within 12 months. So it has liabilities totalling CN¥2.94b more than its cash and near-term receivables, combined.

Fushun Special SteelLTD has a market capitalization of CN¥11.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

Fushun Special SteelLTD's net debt to EBITDA ratio of about 2.0 suggests only moderate use of debt. And its commanding EBIT of 18.6 times its interest expense, implies the debt load is as light as a peacock feather. Importantly, Fushun Special SteelLTD grew its EBIT by 47% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Fushun Special SteelLTD can strengthen its balance sheet over time. 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 clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Fushun Special SteelLTD saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Fushun Special SteelLTD is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. Considering this range of data points, we think Fushun Special SteelLTD is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Fushun Special SteelLTD is showing 1 warning sign in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.