Magnitogorsk Iron & Steel Works (MCX:MAGN) Could Easily Take On More 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. We note that Public Joint Stock Company Magnitogorsk Iron & Steel Works (MCX:MAGN) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. 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.

Check out 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 2021, Magnitogorsk Iron & Steel Works had US$1.03b of debt, up from US$937.0m a year ago. Click the image for more detail. However, it also had US$907.0m in cash, and so its net debt is US$121.0m.

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

According to the last reported balance sheet, Magnitogorsk Iron & Steel Works had liabilities of US$1.78b due within 12 months, and liabilities of US$1.05b due beyond 12 months. Offsetting this, it had US$907.0m in cash and US$1.21b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$712.0m.

Since publicly traded Magnitogorsk Iron & Steel Works shares are worth a total of US$9.19b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. But either way, Magnitogorsk Iron & Steel Works has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With debt at a measly 0.032 times EBITDA and EBIT covering interest a whopping 333 times, it's clear that Magnitogorsk Iron & Steel Works is not a desperate borrower. Indeed relative to its earnings its debt load seems light as a feather. Better yet, Magnitogorsk Iron & Steel Works grew its EBIT by 320% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. 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're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Magnitogorsk Iron & Steel Works recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Magnitogorsk Iron & Steel Works's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, Magnitogorsk Iron & Steel Works seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Magnitogorsk Iron & Steel Works (at least 2 which are concerning) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.