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.' 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?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
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What Is BlueScope Steel's Net Debt?
The image below, which you can click on for greater detail, shows that BlueScope Steel had debt of AU$185.2m at the end of June 2024, a reduction from AU$244.8m over a year. However, its balance sheet shows it holds AU$1.09b in cash, so it actually has AU$900.3m net cash.
A Look At BlueScope Steel's Liabilities
According to the last reported balance sheet, BlueScope Steel had liabilities of AU$3.09b due within 12 months, and liabilities of AU$1.30b due beyond 12 months. Offsetting these obligations, it had cash of AU$1.09b as well as receivables valued at AU$1.70b due within 12 months. So it has liabilities totalling AU$1.60b more than its cash and near-term receivables, combined.
Since publicly traded BlueScope Steel shares are worth a total of AU$9.46b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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 12%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if BlueScope Steel can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. BlueScope Steel 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. During the last three years, BlueScope Steel produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
While BlueScope Steel does have more liabilities than liquid assets, it also has net cash of AU$900.3m. So we don't have any problem with BlueScope Steel's use of debt. 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. For example, we've discovered 1 warning sign for BlueScope Steel that you should be aware of before investing here.
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.
About ASX:BSL
BlueScope Steel
Engages in the production and marketing of metal coated and painted steel building products in Australia, New Zealand, Asia, North America, and internationally.
Flawless balance sheet, good value and pays a dividend.