Is Steel Exchange India (NSE:STEELXIND) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Exchange India Limited (NSE:STEELXIND) does use debt in its business. 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. 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, 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.

See our latest analysis for Steel Exchange India

What Is Steel Exchange India's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Steel Exchange India had ₹7.50b of debt in September 2020, down from ₹8.68b, one year before. Net debt is about the same, since the it doesn't have much cash.

How Healthy Is Steel Exchange India's Balance Sheet?

The latest balance sheet data shows that Steel Exchange India had liabilities of ₹10.4b due within a year, and liabilities of ₹1.32b falling due after that. On the other hand, it had cash of ₹141.9m and ₹233.3m worth of receivables due within a year. So its liabilities total ₹11.4b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₹2.74b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Steel Exchange India would likely require a major re-capitalisation if it had to pay its creditors today.

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.

As it happens Steel Exchange India has a fairly concerning net debt to EBITDA ratio of 11.1 but very strong interest coverage of 12.3. So either it has access to very cheap long term debt or that interest expense is going to grow! Notably, Steel Exchange India's EBIT launched higher than Elon Musk, gaining a whopping 861% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Steel Exchange India 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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 two years, Steel Exchange India 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

We feel some trepidation about Steel Exchange India's difficulty level of total liabilities, but we've got positives to focus on, too. For example, its interest cover and conversion of EBIT to free cash flow give us some confidence in its ability to manage its debt. We think that Steel Exchange India's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. Case in point: We've spotted 3 warning signs for Steel Exchange India you should be aware of, and 1 of them is a bit concerning.

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. 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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