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. We can see that Metallurgical Corporation of China Ltd. (HKG:1618) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. 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, 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.
Check out our latest analysis for Metallurgical Corporation of China
What Is Metallurgical Corporation of China's Net Debt?
The chart below, which you can click on for greater detail, shows that Metallurgical Corporation of China had CN¥94.6b in debt in September 2024; about the same as the year before. However, it does have CN¥33.7b in cash offsetting this, leading to net debt of about CN¥60.9b.
How Healthy Is Metallurgical Corporation of China's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Metallurgical Corporation of China had liabilities of CN¥497.0b due within 12 months and liabilities of CN¥44.6b due beyond that. Offsetting this, it had CN¥33.7b in cash and CN¥390.1b in receivables that were due within 12 months. So it has liabilities totalling CN¥117.9b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the CN¥64.0b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Metallurgical Corporation of China would probably need a major re-capitalization if its creditors were to demand repayment.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Metallurgical Corporation of China's net debt is 3.6 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 28.2 is very high, suggesting that the interest expense on the debt is currently quite low. Importantly, Metallurgical Corporation of China's EBIT fell a jaw-dropping 38% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Metallurgical Corporation of China'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Metallurgical Corporation of China basically broke even on a free cash flow basis. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.
Our View
To be frank both Metallurgical Corporation of China's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its interest cover is a good sign, and makes us more optimistic. After considering the datapoints discussed, we think Metallurgical Corporation of China has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. To that end, you should be aware of the 2 warning signs we've spotted with Metallurgical Corporation of China .
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.