David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that United States Steel Company (NYSE:X) uses debt in its business. But should shareholders worry about its use of debt?
What risk does debt carry?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.
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What is United States Steel’s net debt?
You can click on the chart below for historical numbers, but it shows United States Steel had $3.71 billion in debt in June 2022, up from $5.37 billion a year earlier. However, since it has a cash reserve of $3.04 billion, its net debt is less, at around $677.0 million.
A Look at United States Steel’s Liabilities
According to the last published balance sheet, United States Steel had liabilities of $4.57 billion due within 12 months and liabilities of $5.00 billion due beyond 12 months. In return, he had $3.04 billion in cash and $2.60 billion in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (current) receivables by $3.93 billion.
This is a mountain of leverage compared to its market capitalization of US$5.14 billion. 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.
United States Steel has a low debt to EBITDA ratio of just 0.10. And remarkably, although she has net debt, she has actually received more interest in the last twelve months than she has had to pay. So there’s no doubt that this company can go into debt and still be cool as a cucumber. What is even more impressive is that United States Steel increased its EBIT by 387% year-over-year. This boost will make it even easier to pay off debt in the future. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether United States 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.
Finally, while the taxman may love accounting profits, lenders only accept cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past two years, United States Steel has had free cash flow of 65% of its EBIT, which is about normal given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
The good news is that United States Steel’s demonstrated ability to cover interest costs with EBIT delights us like a fluffy puppy does a toddler. But truth be told, we think his total passive level undermines that impression a bit. When we consider the range of factors above, it seems that United States Steel is quite sensitive with its use of debt. While this carries some risk, it can also improve shareholder returns. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 1 warning sign for United States Steel you should know.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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Find out if Steel in the United States is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.
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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.