Health Check: How Prudently Does Xiwang Special Steel (HKG:1266) Use Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Xiwang Special Steel Company Limited (HKG:1266) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Xiwang Special Steel

What Is Xiwang Special Steel's Net Debt?

As you can see below, Xiwang Special Steel had CN¥4.16b of debt at June 2020, down from CN¥4.52b a year prior. However, it also had CN¥793.1m in cash, and so its net debt is CN¥3.36b.

How Strong Is Xiwang Special Steel's Balance Sheet?

According to the last reported balance sheet, Xiwang Special Steel had liabilities of CN¥8.00b due within 12 months, and liabilities of CN¥1.43b due beyond 12 months. Offsetting this, it had CN¥793.1m in cash and CN¥437.9m in receivables that were due within 12 months. So its liabilities total CN¥8.20b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥905.3m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Xiwang Special Steel would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is Xiwang Special Steel's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Xiwang Special Steel had a loss before interest and tax, and actually shrunk its revenue by 17%, to CN¥10.0b. That's not what we would hope to see.

Caveat Emptor

While Xiwang Special Steel's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable CN¥258m at the EBIT level. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Sure, the company might have a nice story about how they are going on to a brighter future. But the reality is that it is low on liquid assets relative to liabilities, and it lost CN¥436m in the last year. So we're not very excited about owning this stock. Its too risky for us. 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 Xiwang Special Steel is showing 3 warning signs in our investment analysis , and 2 of those make us uncomfortable...

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. 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.
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