Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Olympic Steel, Inc. (NASDAQ:ZEUS) makes use of debt. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. 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. 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.
How Much Debt Does Olympic Steel Carry?
You can click the graphic below for the historical numbers, but it shows that Olympic Steel had US$177.3m of debt in September 2020, down from US$226.8m, one year before. However, it also had US$5.14m in cash, and so its net debt is US$172.2m.
How Healthy Is Olympic Steel's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Olympic Steel had liabilities of US$96.5m due within 12 months and liabilities of US$224.0m due beyond that. Offsetting these obligations, it had cash of US$5.14m as well as receivables valued at US$148.6m due within 12 months. So its liabilities total US$166.8m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of US$171.1m, so it does suggest shareholders should keep an eye on Olympic Steel's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Olympic Steel's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Over 12 months, Olympic Steel made a loss at the EBIT level, and saw its revenue drop to US$1.2b, which is a fall of 28%. To be frank that doesn't bode well.
While Olympic Steel's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at US$3.8m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of US$8.3m. 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. For instance, we've identified 2 warning signs for Olympic Steel that you should be aware of.
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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