Is BlueScope Steel (ASX:BSL) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 BlueScope Steel Limited (ASX:BSL) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for BlueScope Steel

What Is BlueScope Steel's Net Debt?

As you can see below, at the end of June 2022, BlueScope Steel had AU$777.2m of debt, up from AU$622.5m a year ago. Click the image for more detail. However, it does have AU$1.68b in cash offsetting this, leading to net cash of AU$905.5m.

A Look At BlueScope Steel's Liabilities

We can see from the most recent balance sheet that BlueScope Steel had liabilities of AU$4.74b falling due within a year, and liabilities of AU$1.42b due beyond 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 total AU$2.30b more than the combination of its cash and short-term receivables.

BlueScope Steel has a market capitalization of AU$7.68b, 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. 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 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's not great, when it comes to paying down debt.

Summing Up

While BlueScope Steel does have more liabilities than liquid assets, it also has net cash of AU$905.5m. And we liked the look of last year's 121% year-on-year EBIT growth. So we don't think BlueScope Steel's use of debt is risky. 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. Be aware that BlueScope Steel is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.