Here's Why Century Iron and Steel IndustrialLtd (TWSE:9958) Has A Meaningful Debt Burden

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 can see that Century Iron and Steel Industrial Co.,Ltd. (TWSE:9958) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Century Iron and Steel IndustrialLtd

What Is Century Iron and Steel IndustrialLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2023 Century Iron and Steel IndustrialLtd had debt of NT$14.4b, up from NT$10.4b in one year. On the flip side, it has NT$2.00b in cash leading to net debt of about NT$12.4b.

How Strong Is Century Iron and Steel IndustrialLtd's Balance Sheet?

The latest balance sheet data shows that Century Iron and Steel IndustrialLtd had liabilities of NT$8.42b due within a year, and liabilities of NT$13.4b falling due after that. Offsetting these obligations, it had cash of NT$2.00b as well as receivables valued at NT$7.98b due within 12 months. So it has liabilities totalling NT$11.8b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Century Iron and Steel IndustrialLtd has a market capitalization of NT$47.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With net debt to EBITDA of 4.5 Century Iron and Steel IndustrialLtd has a fairly noticeable amount of debt. But the high interest coverage of 7.2 suggests it can easily service that debt. Pleasingly, Century Iron and Steel IndustrialLtd is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 1,994% gain in the last twelve months. 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 Century Iron and Steel IndustrialLtd'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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Century Iron and Steel IndustrialLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither Century Iron and Steel IndustrialLtd's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. We think that Century Iron and Steel IndustrialLtd's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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 4 warning signs for Century Iron and Steel IndustrialLtd (2 are a bit concerning!) that you should be aware of before investing here.

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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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.