These 4 Measures Indicate That Lloyds Steels Industries (NSE:LSIL) Is Using Debt Reasonably Well

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. Importantly, Lloyds Steels Industries Limited (NSE:LSIL) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Lloyds Steels Industries

What Is Lloyds Steels Industries's Net Debt?

As you can see below, at the end of September 2022, Lloyds Steels Industries had ₹193.3m of debt, up from ₹4.04m a year ago. Click the image for more detail. However, it does have ₹140.2m in cash offsetting this, leading to net debt of about ₹53.1m.

How Healthy Is Lloyds Steels Industries' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Lloyds Steels Industries had liabilities of ₹861.3m due within 12 months and liabilities of ₹282.8m due beyond that. Offsetting these obligations, it had cash of ₹140.2m as well as receivables valued at ₹792.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹211.8m.

Having regard to Lloyds Steels Industries' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹17.4b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, Lloyds Steels Industries has virtually no net debt, so it's fair to say it does not have a heavy debt load!

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Lloyds Steels Industries has a low debt to EBITDA ratio of only 0.20. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. It was also good to see that despite losing money on the EBIT line last year, Lloyds Steels Industries turned things around in the last 12 months, delivering and EBIT of ₹248m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Lloyds Steels Industries will need earnings to service that debt. 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 it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Lloyds Steels Industries saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Lloyds Steels Industries's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. Considering this range of data points, we think Lloyds Steels Industries is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Lloyds Steels Industries (2 shouldn't be ignored!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.