David Iben put it well when he said, “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We notice that Olympic Steel, Inc. (NASDAQ: ZEUS) has debt on its balance sheet. But the most important question is: what risk does this debt create?
What risk does debt entail?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Check out our latest review for Olympic Steel
What is the debt of Olympic Steel?
You can click on the graph below for historical figures, but it shows that as of September 2021, Olympic Steel had a debt of US $ 301.6 million, an increase from US $ 177.3 million. , over one year. However, because it has a cash reserve of US $ 15.1 million, its net debt is less, at approximately US $ 286.5 million.
How strong is Olympic Steel’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Olympic Steel had liabilities of US $ 229.4 million owed within 12 months and liabilities of US $ 343.2 million owed beyond that. In compensation for these obligations, he had cash of US $ 15.1 million as well as receivables valued at US $ 303.2 million maturing within 12 months. It therefore has a liability totaling US $ 254.3 million more than its cash and short-term receivables combined.
Since this deficit is actually greater than the company’s market cap of $ 250.5 million, we think shareholders should really watch Olympic Steel’s debt levels, like a parent watching their child. riding a bike for the first time. In the event that the company were to clean up its balance sheet quickly, it seems likely that shareholders would suffer significant dilution.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its earnings before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). Thus, we look at debt versus earnings with and without amortization expenses.
We would say that Olympic Steel’s moderate net debt to EBITDA ratio (being 1.9) indicates leverage cautious. And its imposing EBIT of 19.6 times its interest costs, means the debt burden is as light as a peacock feather. We also note that Olympic Steel improved its EBIT from a loss last year to a positive amount of US $ 142 million. When analyzing debt levels, the balance sheet is the obvious place to start. But it is future profits, more than anything, that will determine Olympic Steel’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. It is therefore worth checking to what extent profit before interest and taxes (EBIT) is supported by free cash flow. Over the past year, Olympic Steel has experienced substantial total negative free cash flow. While investors no doubt expect this situation to reverse in due course, this clearly means its use of debt is riskier.
Our point of view
We would go so far as to say that Olympic Steel’s conversion of EBIT to free cash flow was disappointing. But at least it’s decent enough to cover its interest costs with its EBIT; it’s encouraging. Overall, we think it’s fair to say that Olympic Steel has enough debt that there is real risk around the balance sheet. If all goes well, this should increase returns, but on the other hand, the risk of permanent capital loss is increased by debt. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risks lie on the balance sheet – far from it. For example, Olympic Steel has 4 warning signs (and 3 that make us uncomfortable) we think you should know about.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash-flow-growing stocks.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.