Steel Authority of India (NSE:SAIL) Seems To Be Using A Lot Of Debt

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.' 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 can see that Steel Authority of India Limited (NSE:SAIL) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Steel Authority of India

How Much Debt Does Steel Authority of India Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Steel Authority of India had debt of ₹356.1b, up from ₹254.9b in one year. On the flip side, it has ₹7.54b in cash leading to net debt of about ₹348.6b.

A Look At Steel Authority of India's Liabilities

According to the last reported balance sheet, Steel Authority of India had liabilities of ₹525.8b due within 12 months, and liabilities of ₹295.7b due beyond 12 months. Offsetting this, it had ₹7.54b in cash and ₹70.4b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹743.6b.

This deficit casts a shadow over the ₹483.7b 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, Steel Authority of India 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Steel Authority of India's debt to EBITDA ratio (3.3) suggests that it uses some debt, its interest cover is very weak, at 2.4, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Investors should also be troubled by the fact that Steel Authority of India saw its EBIT drop by 12% over the last twelve months. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Steel Authority of India's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Steel Authority of India recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On the face of it, Steel Authority of India's conversion of EBIT to free cash flow 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. And even its EBIT growth rate fails to inspire much confidence. Taking into account all the aforementioned factors, it looks like Steel Authority of India has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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 instance, we've identified 2 warning signs for Steel Authority of India (1 shouldn't be ignored) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.