Is Maanshan Iron & Steel (HKG:323) Using Debt In A Risky Way?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Maanshan Iron & Steel Company Limited (HKG:323) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Maanshan Iron & Steel

What Is Maanshan Iron & Steel's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Maanshan Iron & Steel had debt of CN¥19.2b, up from CN¥15.2b in one year. However, because it has a cash reserve of CN¥6.36b, its net debt is less, at about CN¥12.9b.

A Look At Maanshan Iron & Steel's Liabilities

The latest balance sheet data shows that Maanshan Iron & Steel had liabilities of CN¥44.3b due within a year, and liabilities of CN¥8.62b falling due after that. On the other hand, it had cash of CN¥6.36b and CN¥4.46b worth of receivables due within a year. So it has liabilities totalling CN¥42.1b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥19.3b 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, Maanshan Iron & 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 future earnings, more than anything, that will determine Maanshan Iron & Steel's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Maanshan Iron & Steel had a loss before interest and tax, and actually shrunk its revenue by 16%, to CN¥95b. We would much prefer see growth.

Caveat Emptor

While Maanshan Iron & 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¥4.4b at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of CN¥904m over the last twelve months. So suffice it to say we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Maanshan Iron & Steel you should be aware of.

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.