Is Magnitogorsk Iron & Steel Works (MCX:MAGN) Using Too Much 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.' 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. As with many other companies Public Joint Stock Company Magnitogorsk Iron & Steel Works (MCX:MAGN) makes use of debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Magnitogorsk Iron & Steel Works

What Is Magnitogorsk Iron & Steel Works's Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Magnitogorsk Iron & Steel Works had debt of US$984.0m, up from US$883.0m in one year. However, it does have US$997.0m in cash offsetting this, leading to net cash of US$13.0m.

How Strong Is Magnitogorsk Iron & Steel Works' Balance Sheet?

According to the last reported balance sheet, Magnitogorsk Iron & Steel Works had liabilities of US$1.70b due within 12 months, and liabilities of US$1.06b due beyond 12 months. Offsetting this, it had US$997.0m in cash and US$1.18b in receivables that were due within 12 months. So it has liabilities totalling US$586.0m more than its cash and near-term receivables, combined.

Of course, Magnitogorsk Iron & Steel Works has a titanic market capitalization of US$10.9b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. 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!

Even more impressive was the fact that Magnitogorsk Iron & Steel Works grew its EBIT by 166% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Magnitogorsk Iron & Steel Works'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.

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. During the last three years, Magnitogorsk Iron & Steel Works produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

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$13.0m. And it impressed us with its EBIT growth of 166% over the last year. So we don't think Magnitogorsk Iron & Steel Works's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Magnitogorsk Iron & Steel Works is showing 3 warning signs in our investment analysis , and 1 of those is a bit concerning...

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.

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.

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