Here's Why BlueScope Steel (ASX:BSL) Can Manage Its Debt Responsibly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, BlueScope Steel Limited (ASX:BSL) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for BlueScope Steel

How Much Debt Does BlueScope Steel Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 BlueScope Steel had AU$777.2m of debt, an increase on AU$622.5m, over one year. However, its balance sheet shows it holds AU$1.68b in cash, so it actually has AU$905.5m net cash.

How Healthy Is BlueScope Steel's Balance Sheet?

The latest balance sheet data shows that BlueScope Steel had liabilities of AU$4.74b due within a year, and liabilities of AU$1.42b falling due after that. Offsetting these obligations, it had cash of AU$1.68b as well as receivables valued at AU$2.18b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$2.30b.

BlueScope Steel has a market capitalization of AU$7.04b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, BlueScope Steel boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that BlueScope Steel grew its EBIT by 121% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine BlueScope Steel's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While BlueScope Steel has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, BlueScope Steel recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While BlueScope Steel does have more liabilities than liquid assets, it also has net cash of AU$905.5m. And it impressed us with its EBIT growth of 121% over the last year. So is BlueScope Steel's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for BlueScope Steel (of which 1 can't be ignored!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.