Here's Why Shiv Aum Steels (NSE:SHIVAUM) Can Manage Its Debt Responsibly

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. We can see that Shiv Aum Steels Limited (NSE:SHIVAUM) does use debt in its business. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Shiv Aum Steels

What Is Shiv Aum Steels's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Shiv Aum Steels had debt of ₹469.8m, up from ₹346.0m in one year. However, it does have ₹28.5m in cash offsetting this, leading to net debt of about ₹441.3m.

How Healthy Is Shiv Aum Steels' Balance Sheet?

The latest balance sheet data shows that Shiv Aum Steels had liabilities of ₹430.0m due within a year, and liabilities of ₹90.6m falling due after that. On the other hand, it had cash of ₹28.5m and ₹566.3m worth of receivables due within a year. So it can boast ₹74.2m more liquid assets than total liabilities.

This surplus suggests that Shiv Aum Steels has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Shiv Aum Steels has a debt to EBITDA ratio of 2.5 and its EBIT covered its interest expense 4.7 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. It is well worth noting that Shiv Aum Steels's EBIT shot up like bamboo after rain, gaining 38% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shiv Aum Steels will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. Over the last three years, Shiv Aum Steels 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

Shiv Aum Steels'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 EBIT growth rate. When we consider all the elements mentioned above, it seems to us that Shiv Aum Steels is managing its debt quite well. 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. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Shiv Aum Steels (including 2 which can't be ignored) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.