Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Sinosteel New Materials Co., Ltd. (SZSE:002057) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Sinosteel New Materials's Debt?
You can click the graphic below for the historical numbers, but it shows that Sinosteel New Materials had CN¥358.0m of debt in September 2024, down from CN¥438.9m, one year before. However, it does have CN¥1.24b in cash offsetting this, leading to net cash of CN¥880.4m.
How Healthy Is Sinosteel New Materials' Balance Sheet?
The latest balance sheet data shows that Sinosteel New Materials had liabilities of CN¥1.40b due within a year, and liabilities of CN¥205.9m falling due after that. Offsetting these obligations, it had cash of CN¥1.24b as well as receivables valued at CN¥1.62b due within 12 months. So it actually has CN¥1.25b more liquid assets than total liabilities.
This surplus suggests that Sinosteel New Materials is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Sinosteel New Materials boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Sinosteel New Materials if management cannot prevent a repeat of the 33% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sinosteel New Materials will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sinosteel New Materials 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. Looking at the most recent three years, Sinosteel New Materials recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Summing Up
While it is always sensible to investigate a company's debt, in this case Sinosteel New Materials has CN¥880.4m in net cash and a decent-looking balance sheet. So we don't have any problem with Sinosteel New Materials'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. We've identified 3 warning signs with Sinosteel New Materials , and understanding them should be part of your investment process.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
