These 4 metrics indicate that Olympic Steel (NASDAQ:ZEUS) is using debt reasonably well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, Olympic Steel, Inc. (NASDAQ:ZEUS) is in debt. But the more important question is: what risk does this debt create?

What risk does debt carry?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, 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 frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, many companies use debt to finance their growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest analysis for Olympic Steel

What is Olympic Steel’s net debt?

The image below, which you can click on for more details, shows that in March 2022, Olympic Steel had a debt of $311.6 million, compared to $196.6 million in one year. However, since he has a cash reserve of $8.01 million, his net debt is less, at around $303.5 million.

NasdaqGS: ZEUS Debt to Equity May 28, 2022

How strong is Olympic Steel’s balance sheet?

We can see from the most recent balance sheet that Olympic Steel had liabilities of $220.0 million due in one year, and liabilities of $360.9 million beyond. On the other hand, it had liquidities of 8.01 million dollars and 313.1 million dollars of accounts receivable within one year. Thus, its liabilities total $259.8 million more than the combination of its cash and short-term receivables.

This is a mountain of leverage compared to its market capitalization of US$404.4 million. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet quickly.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.

Olympic Steel has a low net debt to EBITDA ratio of just 1.4. And its EBIT easily covers its interest charges, being 24.3 times higher. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Even better, Olympic Steel increased its EBIT by 566% last year, which is an impressive improvement. If sustained, this growth will make debt even more manageable in years to come. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Olympic Steel can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Olympic Steel has created free cash flow of 13% of its EBIT, an uninspiring performance. This low level of cash conversion compromises its ability to manage and repay its debt.

Our point of view

Olympic Steel’s interest coverage was a real advantage in this analysis, as was its EBIT growth rate. On the other hand, its conversion of EBIT into free cash flow makes us a little less comfortable about its debt. Given this range of data points, we believe Olympic Steel is in a good position to manage its level of leverage. That said, the charge is heavy enough that we recommend that any shareholder keep a close eye on it. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, Olympic Steel has 5 warning signs (and 3 that we don’t like too much) that we think you should know about.

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.