Is Chongqing Iron & Steel (HKG:1053) Using Debt Sensibly?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Chongqing Iron & Steel Company Limited (HKG:1053) does use debt in its business. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Chongqing Iron & Steel

What Is Chongqing Iron & Steel's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2023 Chongqing Iron & Steel had debt of CN¥5.71b, up from CN¥4.38b in one year. On the flip side, it has CN¥2.00b in cash leading to net debt of about CN¥3.71b.

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¥12.7b due within 12 months and liabilities of CN¥5.02b due beyond that. On the other hand, it had cash of CN¥2.00b and CN¥1.69b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥14.0b.

When you consider that this deficiency exceeds the company's CN¥13.9b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. 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.

Over 12 months, Chongqing Iron & Steel saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.

Caveat Emptor

Importantly, Chongqing Iron & Steel had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable CN¥1.5b at the EBIT level. 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¥2.1b in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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. Be aware that Chongqing Iron & Steel is showing 1 warning sign in our investment analysis , you should know about...

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.