Metallurgical Corporation of China (HKG:1618) Has A Pretty Healthy Balance Sheet

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. As with many other companies Metallurgical Corporation of China Ltd. (HKG:1618) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. 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?

As you can see below, at the end of March 2022, Metallurgical Corporation of China had CN¥90.6b of debt, up from CN¥75.4b a year ago. Click the image for more detail. However, it does have CN¥54.4b in cash offsetting this, leading to net debt of about CN¥36.2b.

A Look At Metallurgical Corporation of China's Liabilities

Zooming in on the latest balance sheet data, we can see that Metallurgical Corporation of China had liabilities of CN¥391.9b due within 12 months and liabilities of CN¥37.2b due beyond that. Offsetting this, it had CN¥54.4b in cash and CN¥278.3b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥96.5b.

When you consider that this deficiency exceeds the company's CN¥66.6b 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.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

We'd say that Metallurgical Corporation of China's moderate net debt to EBITDA ratio ( being 1.6), indicates prudence when it comes to debt. And its commanding EBIT of 1k times its interest expense, implies the debt load is as light as a peacock feather. Also good is that Metallurgical Corporation of China grew its EBIT at 13% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Metallurgical Corporation of China's ability to maintain a healthy balance sheet going forward. 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Metallurgical Corporation of China actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Metallurgical Corporation of China's interest cover was a real positive on this analysis, as was its conversion of EBIT to free cash flow. But truth be told its level of total liabilities had us nibbling our nails. Looking at all this data makes us feel a little cautious about Metallurgical Corporation of China's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Metallurgical Corporation of China has 1 warning sign we think you should be aware of.

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.