These 4 Measures Indicate That Kalyani Steels (NSE:KSL) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Kalyani Steels Limited (NSE:KSL) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kalyani Steels

What Is Kalyani Steels's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Kalyani Steels had debt of ₹547.4m, up from ₹78.1m in one year. However, its balance sheet shows it holds ₹4.05b in cash, so it actually has ₹3.50b net cash.

How Healthy Is Kalyani Steels' Balance Sheet?

The latest balance sheet data shows that Kalyani Steels had liabilities of ₹3.91b due within a year, and liabilities of ₹472.9m falling due after that. Offsetting these obligations, it had cash of ₹4.05b as well as receivables valued at ₹2.62b due within 12 months. So it can boast ₹2.29b more liquid assets than total liabilities.

It's good to see that Kalyani Steels has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Kalyani Steels has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Kalyani Steels's load is not too heavy, because its EBIT was down 24% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Kalyani Steels 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. While Kalyani Steels has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Kalyani Steels actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Kalyani Steels has net cash of ₹3.50b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of ₹677m, being 102% of its EBIT. So is Kalyani Steels's debt a risk? It doesn't seem so to us. 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. Be aware that Kalyani Steels is showing 2 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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