Does Schnitzer Steel Industries (NASDAQ:SCHN) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Schnitzer Steel Industries, Inc. (NASDAQ:SCHN) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Schnitzer Steel Industries

How Much Debt Does Schnitzer Steel Industries Carry?

As you can see below, at the end of May 2022, Schnitzer Steel Industries had US$321.9m of debt, up from US$153.8m a year ago. Click the image for more detail. On the flip side, it has US$16.1m in cash leading to net debt of about US$305.7m.

How Strong Is Schnitzer Steel Industries' Balance Sheet?

We can see from the most recent balance sheet that Schnitzer Steel Industries had liabilities of US$380.9m falling due within a year, and liabilities of US$563.7m due beyond that. Offsetting these obligations, it had cash of US$16.1m as well as receivables valued at US$285.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$643.3m.

This deficit is considerable relative to its market capitalization of US$967.5m, so it does suggest shareholders should keep an eye on Schnitzer Steel Industries' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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

Schnitzer Steel Industries has a low net debt to EBITDA ratio of only 1.1. And its EBIT easily covers its interest expense, being 34.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also positive, Schnitzer Steel Industries grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. 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 Schnitzer Steel Industries's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Schnitzer Steel Industries's free cash flow amounted to 29% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Schnitzer Steel Industries's interest cover was a real positive on this analysis, as was its EBIT growth rate. Having said that, its level of total liabilities somewhat sensitizes us to potential future risks to the balance sheet. Considering this range of data points, we think Schnitzer Steel Industries is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Be aware that Schnitzer Steel Industries is showing 1 warning sign in our investment analysis , you should know about...

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.