Here's Why Sinosteel New Materials (SZSE:002057) Can Manage Its Debt Responsibly

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. Importantly, Sinosteel New Materials Co., Ltd. (SZSE:002057) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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

View our latest analysis for Sinosteel New Materials

How Much Debt Does Sinosteel New Materials Carry?

The image below, which you can click on for greater detail, shows that Sinosteel New Materials had debt of CN¥358.0m at the end of September 2024, a reduction from CN¥438.9m over a year. But on the other hand it also has CN¥1.24b in cash, leading to a CN¥880.4m net cash position.

A Look At Sinosteel New Materials' Liabilities

We can see from the most recent balance sheet that Sinosteel New Materials had liabilities of CN¥1.40b falling due within a year, and liabilities of CN¥205.9m due beyond that. Offsetting this, it had CN¥1.24b in cash and CN¥1.62b in receivables that were due within 12 months. So it actually has CN¥1.25b more liquid assets than total liabilities.

This excess liquidity suggests that Sinosteel New Materials is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Sinosteel New Materials has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Sinosteel New Materials's load is not too heavy, because its EBIT was down 33% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sinosteel New Materials'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Sinosteel New Materials may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Sinosteel New Materials recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sinosteel New Materials has net cash of CN¥880.4m, as well as more liquid assets than liabilities. So we don't have any problem with Sinosteel New Materials's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Sinosteel New Materials 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.