Stock Analysis

Here's Why JSW Steel (NSE:JSWSTEEL) Can Manage Its Debt Responsibly

NSEI:JSWSTEEL
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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 note that JSW Steel Limited (NSE:JSWSTEEL) does have debt on its balance sheet. 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. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.

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How Much Debt Does JSW Steel Carry?

As you can see below, at the end of September 2021, JSW Steel had ₹709.1b of debt, up from ₹500.1b a year ago. Click the image for more detail. However, because it has a cash reserve of ₹150.1b, its net debt is less, at about ₹559.0b.

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NSEI:JSWSTEEL Debt to Equity History January 25th 2022

A Look At JSW Steel's Liabilities

Zooming in on the latest balance sheet data, we can see that JSW Steel had liabilities of ₹470.0b due within 12 months and liabilities of ₹636.6b due beyond that. Offsetting these obligations, it had cash of ₹150.1b as well as receivables valued at ₹72.5b due within 12 months. So it has liabilities totalling ₹883.9b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since JSW Steel has a huge market capitalization of ₹1.50t, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

With net debt sitting at just 1.5 times EBITDA, JSW Steel is arguably pretty conservatively geared. And it boasts interest cover of 9.3 times, which is more than adequate. Better yet, JSW Steel grew its EBIT by 205% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if JSW 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, JSW Steel recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

On our analysis JSW Steel's EBIT growth rate should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. When we consider all the elements mentioned above, it seems to us that JSW Steel 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that JSW Steel is showing 3 warning signs in our investment analysis , and 1 of those is significant...

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.