Does Companhia Siderúrgica Nacional (BVMF:CSNA3) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Companhia Siderúrgica Nacional (BVMF:CSNA3) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Companhia Siderúrgica Nacional

What Is Companhia Siderúrgica Nacional's Debt?

As you can see below, at the end of March 2023, Companhia Siderúrgica Nacional had R$42.4b of debt, up from R$30.9b a year ago. Click the image for more detail. However, because it has a cash reserve of R$14.9b, its net debt is less, at about R$27.4b.

A Look At Companhia Siderúrgica Nacional's Liabilities

Zooming in on the latest balance sheet data, we can see that Companhia Siderúrgica Nacional had liabilities of R$19.8b due within 12 months and liabilities of R$45.1b due beyond that. Offsetting these obligations, it had cash of R$14.9b as well as receivables valued at R$5.59b due within 12 months. So its liabilities total R$44.4b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the R$16.1b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Companhia Siderúrgica Nacional would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about Companhia Siderúrgica Nacional's net debt to EBITDA ratio of 3.6, we think its super-low interest cover of 2.5 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Worse, Companhia Siderúrgica Nacional's EBIT was down 71% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Companhia Siderúrgica Nacional'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Companhia Siderúrgica Nacional recorded free cash flow worth 51% 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.

Our View

On the face of it, Companhia Siderúrgica Nacional's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least its conversion of EBIT to free cash flow is not so bad. Taking into account all the aforementioned factors, it looks like Companhia Siderúrgica Nacional has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. We've identified 2 warning signs with Companhia Siderúrgica Nacional , and understanding them should be part of your investment process.

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.