Is Steel Strips Wheels (NSE:SSWL) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Steel Strips Wheels Limited (NSE:SSWL) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Steel Strips Wheels

What Is Steel Strips Wheels's Net Debt?

As you can see below, at the end of September 2020, Steel Strips Wheels had ₹10.2b of debt, up from ₹9.79b a year ago. Click the image for more detail. However, because it has a cash reserve of ₹560.9m, its net debt is less, at about ₹9.67b.

How Healthy Is Steel Strips Wheels' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Steel Strips Wheels had liabilities of ₹8.25b due within 12 months and liabilities of ₹6.25b due beyond that. Offsetting this, it had ₹560.9m in cash and ₹2.44b in receivables that were due within 12 months. So its liabilities total ₹11.5b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of ₹9.40b, we think shareholders really should watch Steel Strips Wheels's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Steel Strips Wheels shareholders face the double whammy of a high net debt to EBITDA ratio (6.0), and fairly weak interest coverage, since EBIT is just 1.1 times the interest expense. This means we'd consider it to have a heavy debt load. Worse, Steel Strips Wheels's EBIT was down 38% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is Steel Strips Wheels's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Steel Strips Wheels recorded free cash flow of 22% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, Steel Strips Wheels's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And even its level of total liabilities fails to inspire much confidence. After considering the datapoints discussed, we think Steel Strips Wheels has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Steel Strips Wheels that you should be aware of.

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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