These 4 Measures Indicate That BlueScope Steel (ASX:BSL) Is Using Debt Safely

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 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. As with many other companies BlueScope Steel Limited (ASX:BSL) makes use of 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for BlueScope Steel

What Is BlueScope Steel's Debt?

As you can see below, BlueScope Steel had AU$705.0m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. But it also has AU$1.90b in cash to offset that, meaning it has AU$1.20b net cash.

How Healthy Is BlueScope Steel's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that BlueScope Steel had liabilities of AU$3.53b due within 12 months and liabilities of AU$1.71b due beyond that. Offsetting these obligations, it had cash of AU$1.90b as well as receivables valued at AU$1.84b due within 12 months. So its liabilities total AU$1.50b more than the combination of its cash and short-term receivables.

Given BlueScope Steel has a market capitalization of AU$8.44b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. 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 361% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

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. Over the most recent three years, BlueScope Steel recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

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$1.20b. And it impressed us with its EBIT growth of 361% over the last year. So we don't think BlueScope Steel's use of debt is risky. 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 BlueScope Steel has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.