Is Steel & Tube Holdings (NZSE:STU) Using Debt Sensibly?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Steel & Tube Holdings Limited (NZSE:STU) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Steel & Tube Holdings

What Is Steel & Tube Holdings's Debt?

As you can see below, Steel & Tube Holdings had NZ$10.0m of debt at June 2020, down from NZ$24.0m a year prior. However, it does have NZ$17.4m in cash offsetting this, leading to net cash of NZ$7.42m.

How Strong Is Steel & Tube Holdings's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Steel & Tube Holdings had liabilities of NZ$58.9m due within 12 months and liabilities of NZ$106.1m due beyond that. On the other hand, it had cash of NZ$17.4m and NZ$61.0m worth of receivables due within a year. So its liabilities total NZ$86.5m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of NZ$122.1m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Steel & Tube Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Steel & Tube Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Steel & Tube Holdings made a loss at the EBIT level, and saw its revenue drop to NZ$418m, which is a fall of 16%. We would much prefer see growth.

So How Risky Is Steel & Tube Holdings?

Although Steel & Tube Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of NZ$32m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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 for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Steel & Tube Holdings , and understanding them should be part of your investment process.

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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