Is Reliance Steel & Aluminum (NYSE:RS) A Risky Investment?

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. As with many other companies Reliance Steel & Aluminum Co. (NYSE:RS) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Reliance Steel & Aluminum

How Much Debt Does Reliance Steel & Aluminum Carry?

As you can see below, Reliance Steel & Aluminum had US$1.14b of debt at September 2023, down from US$1.65b a year prior. However, because it has a cash reserve of US$976.9m, its net debt is less, at about US$165.0m.

A Look At Reliance Steel & Aluminum's Liabilities

According to the last reported balance sheet, Reliance Steel & Aluminum had liabilities of US$878.7m due within 12 months, and liabilities of US$1.88b due beyond 12 months. On the other hand, it had cash of US$976.9m and US$1.67b worth of receivables due within a year. So it has liabilities totalling US$113.5m more than its cash and near-term receivables, combined.

This state of affairs indicates that Reliance Steel & Aluminum's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$15.4b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, Reliance Steel & Aluminum has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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.

With debt at a measly 0.078 times EBITDA and EBIT covering interest a whopping 41.0 times, it's clear that Reliance Steel & Aluminum is not a desperate borrower. So relative to past earnings, the debt load seems trivial. The modesty of its debt load may become crucial for Reliance Steel & Aluminum if management cannot prevent a repeat of the 29% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Reliance Steel & Aluminum 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Reliance Steel & Aluminum produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Based on what we've seen Reliance Steel & Aluminum is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Considering this range of data points, we think Reliance Steel & Aluminum 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Reliance Steel & Aluminum you should be aware of, and 1 of them is a bit unpleasant.

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. 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.