Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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 Tata Steel BSL Limited (NSE:TATASTLBSL) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Tata Steel BSL’s Net Debt?
The chart below, which you can click on for greater detail, shows that Tata Steel BSL had ₹163.9b in debt in September 2019; about the same as the year before. On the flip side, it has ₹9.45b in cash leading to net debt of about ₹154.5b.
How Healthy Is Tata Steel BSL’s Balance Sheet?
According to the last reported balance sheet, Tata Steel BSL had liabilities of ₹42.7b due within 12 months, and liabilities of ₹166.9b due beyond 12 months. Offsetting this, it had ₹9.45b in cash and ₹5.73b in receivables that were due within 12 months. So its liabilities total ₹194.5b more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the ₹28.2b 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, Tata Steel BSL would probably need a major re-capitalization if its creditors were to demand repayment.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
While Tata Steel BSL’s debt to EBITDA ratio (5.0) suggests that it uses some debt, its interest cover is very weak, at 0.71, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. However, one redeeming factor is that Tata Steel BSL grew its EBIT at 19% over the last 12 months, boosting its ability to handle its debt. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since Tata Steel BSL 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. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Tata Steel BSL actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
On the face of it, Tata Steel BSL’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. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Tata Steel BSL stock a bit risky. That’s not necessarily a bad thing, but we’d generally feel more comfortable with less leverage. While Tata Steel BSL didn’t make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away.Click here to see if its earnings are heading in the right direction, over the medium term.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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