Is Chongqing Iron & Steel (HKG:1053) Using Debt In A Risky Way?

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.' 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 Chongqing Iron & Steel Company Limited (HKG:1053) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Chongqing Iron & Steel

How Much Debt Does Chongqing Iron & Steel Carry?

The image below, which you can click on for greater detail, shows that Chongqing Iron & Steel had debt of CN¥5.13b at the end of September 2022, a reduction from CN¥5.99b over a year. On the flip side, it has CN¥3.29b in cash leading to net debt of about CN¥1.84b.

How Strong Is Chongqing Iron & Steel's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Chongqing Iron & Steel had liabilities of CN¥13.5b due within 12 months and liabilities of CN¥4.07b due beyond that. Offsetting these obligations, it had cash of CN¥3.29b as well as receivables valued at CN¥1.12b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥13.1b.

This is a mountain of leverage relative to its market capitalization of CN¥13.6b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But it is Chongqing Iron & Steel'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.

In the last year Chongqing Iron & Steel had a loss before interest and tax, and actually shrunk its revenue by 12%, to CN¥34b. That's not what we would hope to see.

Caveat Emptor

Not only did Chongqing Iron & Steel's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥223m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of CN¥877m. So to be blunt we do think it is risky. For riskier companies like Chongqing Iron & Steel I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.