Ryerson Holding (NYSE:RYI) Seems To Use Debt Quite 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.' 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. As with many other companies Ryerson Holding Corporation (NYSE:RYI) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Ryerson Holding

How Much Debt Does Ryerson Holding Carry?

As you can see below, Ryerson Holding had US$476.9m of debt at September 2022, down from US$674.9m a year prior. However, because it has a cash reserve of US$50.9m, its net debt is less, at about US$426.0m.

How Healthy Is Ryerson Holding's Balance Sheet?

We can see from the most recent balance sheet that Ryerson Holding had liabilities of US$705.0m falling due within a year, and liabilities of US$949.6m due beyond that. On the other hand, it had cash of US$50.9m and US$663.1m worth of receivables due within a year. So its liabilities total US$940.6m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$1.16b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Ryerson Holding's net debt is only 0.53 times its EBITDA. And its EBIT covers its interest expense a whopping 20.6 times over. So we're pretty relaxed about its super-conservative use of debt. Better yet, Ryerson Holding grew its EBIT by 152% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Ryerson Holding'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Ryerson Holding recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Ryerson Holding's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its level of total liabilities. Looking at all the aforementioned factors together, it strikes us that Ryerson Holding can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Ryerson Holding that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.