Is Universal Stainless & Alloy Products (NASDAQ:USAP) Using Debt Sensibly?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Universal Stainless & Alloy Products, Inc. (NASDAQ:USAP) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Universal Stainless & Alloy Products

What Is Universal Stainless & Alloy Products's Debt?

You can click the graphic below for the historical numbers, but it shows that Universal Stainless & Alloy Products had US$52.0m of debt in June 2021, down from US$71.3m, one year before. And it doesn't have much cash, so its net debt is about the same.

A Look At Universal Stainless & Alloy Products' Liabilities

Zooming in on the latest balance sheet data, we can see that Universal Stainless & Alloy Products had liabilities of US$33.1m due within 12 months and liabilities of US$57.9m due beyond that. Offsetting this, it had US$158.0k in cash and US$21.3m in receivables that were due within 12 months. So its liabilities total US$69.6m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$81.8m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Universal Stainless & Alloy Products's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Universal Stainless & Alloy Products had a loss before interest and tax, and actually shrunk its revenue by 35%, to US$144m. That makes us nervous, to say the least.

Caveat Emptor

Not only did Universal Stainless & Alloy Products's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping US$13m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of US$21m into a profit. In the meantime, we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Universal Stainless & Alloy Products (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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.

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