Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that Xining Special Steel.Co.,Ltd (SHSE:600117) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Xining Special Steel.Co.Ltd Carry?
You can click the graphic below for the historical numbers, but it shows that Xining Special Steel.Co.Ltd had CN¥8.55b of debt in September 2023, down from CN¥9.67b, one year before. Net debt is about the same, since the it doesn't have much cash.
How Strong Is Xining Special Steel.Co.Ltd's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Xining Special Steel.Co.Ltd had liabilities of CN¥12.2b due within 12 months and liabilities of CN¥1.48b due beyond that. Offsetting this, it had CN¥129.6m in cash and CN¥1.34b in receivables that were due within 12 months. So it has liabilities totalling CN¥12.2b more than its cash and near-term receivables, combined.
Given this deficit is actually higher than the company's market capitalization of CN¥9.08b, we think shareholders really should watch Xining Special Steel.Co.Ltd's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Xining Special Steel.Co.Ltd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
In the last year Xining Special Steel.Co.Ltd had a loss before interest and tax, and actually shrunk its revenue by 62%, to CN¥3.9b. That makes us nervous, to say the least.
Caveat Emptor
Not only did Xining Special Steel.Co.Ltd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping CN¥2.1b. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of CN¥1.6b. In the meantime, we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Xining Special Steel.Co.Ltd , 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.