Is Metallurgical Corporation of China (HKG:1618) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Metallurgical Corporation of China Ltd. (HKG:1618) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Metallurgical Corporation of China

What Is Metallurgical Corporation of China's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Metallurgical Corporation of China had debt of CN¥107.4b, up from CN¥89.5b in one year. However, it does have CN¥47.6b in cash offsetting this, leading to net debt of about CN¥59.8b.

How Strong Is Metallurgical Corporation of China's Balance Sheet?

We can see from the most recent balance sheet that Metallurgical Corporation of China had liabilities of CN¥538.6b falling due within a year, and liabilities of CN¥46.9b due beyond that. Offsetting these obligations, it had cash of CN¥47.6b as well as receivables valued at CN¥406.9b due within 12 months. So its liabilities total CN¥131.0b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥51.0b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Metallurgical Corporation of China would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Metallurgical Corporation of China's net debt is 3.8 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 20.6 is very high, suggesting that the interest expense on the debt is currently quite low. Importantly, Metallurgical Corporation of China's EBIT fell a jaw-dropping 42% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Metallurgical Corporation of China 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Metallurgical Corporation of China reported free cash flow worth 18% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

On the face of it, Metallurgical Corporation of China's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Taking into account all the aforementioned factors, it looks like Metallurgical Corporation of China has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. Be aware that Metallurgical Corporation of China is showing 2 warning signs in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.