MSP Steel & Power (NSE:MSPL) Takes On Some Risk With Its Use Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, MSP Steel & Power Limited (NSE:MSPL) does carry debt. But is this debt a concern to shareholders?

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 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for MSP Steel & Power

What Is MSP Steel & Power's Debt?

The chart below, which you can click on for greater detail, shows that MSP Steel & Power had ₹8.52b in debt in September 2020; about the same as the year before. On the flip side, it has ₹197.9m in cash leading to net debt of about ₹8.32b.

A Look At MSP Steel & Power's Liabilities

The latest balance sheet data shows that MSP Steel & Power had liabilities of ₹4.55b due within a year, and liabilities of ₹5.57b falling due after that. On the other hand, it had cash of ₹197.9m and ₹782.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹9.14b.

This deficit casts a shadow over the ₹3.02b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, MSP Steel & Power would probably need a major re-capitalization if its creditors were to demand repayment.

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.

Weak interest cover of 0.66 times and a disturbingly high net debt to EBITDA ratio of 7.6 hit our confidence in MSP Steel & Power like a one-two punch to the gut. The debt burden here is substantial. Looking on the bright side, MSP Steel & Power boosted its EBIT by a silky 72% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is MSP Steel & Power'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, MSP Steel & Power actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, MSP Steel & Power's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that MSP Steel & Power's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for MSP Steel & Power 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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This article by Simply Wall St is general in nature. 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.
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