These 4 Measures Indicate That S.A.L. Steel (NSE:SALSTEEL) Is Using Debt Extensively

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.' 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 S.A.L. Steel Limited (NSE:SALSTEEL) does use debt in its business. But should shareholders be worried about its use of debt?

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 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for S.A.L. Steel

How Much Debt Does S.A.L. Steel Carry?

You can click the graphic below for the historical numbers, but it shows that S.A.L. Steel had ₹1.35b of debt in September 2021, down from ₹1.62b, one year before. Net debt is about the same, since the it doesn't have much cash.

How Healthy Is S.A.L. Steel's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that S.A.L. Steel had liabilities of ₹1.23b due within 12 months and liabilities of ₹1.13b due beyond that. Offsetting this, it had ₹10.8m in cash and ₹477.1m in receivables that were due within 12 months. So its liabilities total ₹1.87b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the ₹915.1m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, S.A.L. Steel would probably need a major re-capitalization if its creditors were to demand repayment.

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

S.A.L. Steel's net debt is 3.7 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 183 is very high, suggesting that the interest expense on the debt is currently quite low. We also note that S.A.L. Steel improved its EBIT from a last year's loss to a positive ₹265m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since S.A.L. Steel 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, S.A.L. Steel generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

We feel some trepidation about S.A.L. Steel's difficulty level of total liabilities, but we've got positives to focus on, too. To wit both its interest cover and conversion of EBIT to free cash flow were encouraging signs. Taking the abovementioned factors together we do think S.A.L. Steel's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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 S.A.L. Steel is showing 3 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

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.