Is BlueScope Steel (ASX:BSL) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 BlueScope Steel Limited (ASX:BSL) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for BlueScope Steel

What Is BlueScope Steel's Debt?

The image below, which you can click on for greater detail, shows that BlueScope Steel had debt of AU$683.7m at the end of December 2020, a reduction from AU$804.7m over a year. But it also has AU$1.50b in cash to offset that, meaning it has AU$811.4m net cash.

How Healthy Is BlueScope Steel's Balance Sheet?

The latest balance sheet data shows that BlueScope Steel had liabilities of AU$2.43b due within a year, and liabilities of AU$1.79b falling due after that. On the other hand, it had cash of AU$1.50b and AU$1.04b worth of receivables due within a year. So it has liabilities totalling AU$1.68b more than its cash and near-term receivables, combined.

Of course, BlueScope Steel has a market capitalization of AU$8.71b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, BlueScope Steel boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, BlueScope Steel's EBIT dived 16%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 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. 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. Over the most recent three years, BlueScope Steel recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

Although BlueScope Steel's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$811.4m. The cherry on top was that in converted 79% of that EBIT to free cash flow, bringing in AU$552m. So we are not troubled with BlueScope Steel's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for BlueScope Steel you should be aware of, and 1 of them is significant.

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.

If you’re looking to trade BlueScope Steel, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.