Is Magnitogorsk Iron & Steel Works (MCX:MAGN) A Risky Investment?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Public Joint Stock Company Magnitogorsk Iron & Steel Works (MCX:MAGN) does carry debt. But should shareholders be worried about its use of debt?

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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Magnitogorsk Iron & Steel Works

How Much Debt Does Magnitogorsk Iron & Steel Works Carry?

As you can see below, at the end of September 2020, Magnitogorsk Iron & Steel Works had US$937.0m of debt, up from US$856.0m a year ago. Click the image for more detail. But on the other hand it also has US$987.0m in cash, leading to a US$50.0m net cash position.

A Look At Magnitogorsk Iron & Steel Works's Liabilities

According to the last reported balance sheet, Magnitogorsk Iron & Steel Works had liabilities of US$1.29b due within 12 months, and liabilities of US$1.07b due beyond 12 months. Offsetting this, it had US$987.0m in cash and US$569.0m in receivables that were due within 12 months. So it has liabilities totalling US$806.0m more than its cash and near-term receivables, combined.

Since publicly traded Magnitogorsk Iron & Steel Works shares are worth a total of US$8.07b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Magnitogorsk Iron & Steel Works boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Magnitogorsk Iron & Steel Works if management cannot prevent a repeat of the 46% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Magnitogorsk Iron & Steel Works can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Magnitogorsk Iron & Steel Works has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Magnitogorsk Iron & Steel Works recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

We could understand if investors are concerned about Magnitogorsk Iron & Steel Works's liabilities, but we can be reassured by the fact it has has net cash of US$50.0m. So we don't have any problem with Magnitogorsk Iron & Steel Works's use of debt. 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. For instance, we've identified 3 warning signs for Magnitogorsk Iron & Steel Works that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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