Health Check: How Prudently Does Guangdong Zhongnan Iron and Steel (SZSE:000717) Use Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Guangdong Zhongnan Iron and Steel Co., Ltd. (SZSE:000717) does use debt in its business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Guangdong Zhongnan Iron and Steel

How Much Debt Does Guangdong Zhongnan Iron and Steel Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Guangdong Zhongnan Iron and Steel had debt of CN¥2.76b, up from CN¥2.53b in one year. On the flip side, it has CN¥1.27b in cash leading to net debt of about CN¥1.49b.

How Healthy Is Guangdong Zhongnan Iron and Steel's Balance Sheet?

We can see from the most recent balance sheet that Guangdong Zhongnan Iron and Steel had liabilities of CN¥8.97b falling due within a year, and liabilities of CN¥2.74b due beyond that. On the other hand, it had cash of CN¥1.27b and CN¥212.7m worth of receivables due within a year. So it has liabilities totalling CN¥10.2b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's CN¥7.66b 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. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Guangdong Zhongnan Iron and Steel will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Guangdong Zhongnan Iron and Steel had a loss before interest and tax, and actually shrunk its revenue by 22%, to CN¥32b. To be frank that doesn't bode well.

Caveat Emptor

While Guangdong Zhongnan Iron and Steel's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping CN¥993m. 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. Not least because it burned through CN¥860m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Guangdong Zhongnan Iron and Steel is showing 2 warning signs in our investment analysis , and 1 of those is significant...

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.