Is China Steel Chemical (TWSE:1723) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 China Steel Chemical Corporation (TWSE:1723) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for China Steel Chemical

How Much Debt Does China Steel Chemical Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 China Steel Chemical had NT$1.40b of debt, an increase on NT$1.23b, over one year. But it also has NT$1.83b in cash to offset that, meaning it has NT$435.5m net cash.

How Healthy Is China Steel Chemical's Balance Sheet?

According to the last reported balance sheet, China Steel Chemical had liabilities of NT$1.52b due within 12 months, and liabilities of NT$1.65b due beyond 12 months. Offsetting these obligations, it had cash of NT$1.83b as well as receivables valued at NT$868.1m due within 12 months. So it has liabilities totalling NT$469.0m more than its cash and near-term receivables, combined.

Having regard to China Steel Chemical's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the NT$28.2b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, China Steel Chemical boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, China Steel Chemical's EBIT dived 15%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine China Steel Chemical's ability to maintain a healthy balance sheet going forward. 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. China Steel Chemical may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, China Steel Chemical recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that China Steel Chemical has NT$435.5m in net cash. The cherry on top was that in converted 91% of that EBIT to free cash flow, bringing in NT$559m. So we don't have any problem with China Steel Chemical's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for China Steel Chemical that you should be aware of before investing here.

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.

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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.