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.' 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 Guangdong Zhongnan Iron and Steel Co., Ltd. (SZSE:000717) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

What Is Guangdong Zhongnan Iron and Steel's Debt?

As you can see below, at the end of September 2023, Guangdong Zhongnan Iron and Steel had CN¥2.53b of debt, up from CN¥2.30b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥1.07b, its net debt is less, at about CN¥1.46b.

How Strong Is Guangdong Zhongnan Iron and Steel's Balance Sheet?

The latest balance sheet data shows that Guangdong Zhongnan Iron and Steel had liabilities of CN¥10.2b due within a year, and liabilities of CN¥2.10b falling due after that. On the other hand, it had cash of CN¥1.07b and CN¥513.3m worth of receivables due within a year. So it has liabilities totalling CN¥10.7b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥5.53b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Guangdong Zhongnan Iron and Steel would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Guangdong Zhongnan Iron and Steel can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Guangdong Zhongnan Iron and Steel reported revenue of CN¥42b, which is a gain of 6.0%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Guangdong Zhongnan Iron and Steel had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping CN¥810m. 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. Not least because it burned through CN¥134m in negative free cash flow over the last year. So suffice it to say we consider the stock to be 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. For example - Guangdong Zhongnan Iron and Steel has 1 warning sign we think you should be aware of.

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.