These 4 Measures Indicate That TimkenSteel (NYSE:TMST) Is Using Debt Safely

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.' 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 TimkenSteel Corporation (NYSE:TMST) makes use of debt. But the real question is whether this debt is making the company risky.

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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for TimkenSteel

What Is TimkenSteel's Net Debt?

As you can see below, TimkenSteel had US$20.4m of debt at June 2022, down from US$44.7m a year prior. However, it does have US$238.5m in cash offsetting this, leading to net cash of US$218.1m.

A Look At TimkenSteel's Liabilities

According to the last reported balance sheet, TimkenSteel had liabilities of US$260.0m due within 12 months, and liabilities of US$188.4m due beyond 12 months. On the other hand, it had cash of US$238.5m and US$159.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$50.0m.

Since publicly traded TimkenSteel shares are worth a total of US$698.5m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, TimkenSteel also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, TimkenSteel grew its EBIT by 384% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine TimkenSteel'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 company can only pay off debt with cold hard cash, not accounting profits. While TimkenSteel has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last two years, TimkenSteel generated free cash flow amounting to a very robust 95% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that TimkenSteel has US$218.1m in net cash. And it impressed us with free cash flow of US$190m, being 95% of its EBIT. So is TimkenSteel's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for TimkenSteel that you should be aware of.

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.