Yahoo Finance These 4 Measures Indicate That Russel Metals (TSE:RUS) Is Using Debt Extensively
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. We can see that Russel Metals Inc. (TSE:RUS) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Russel Metals
What Is Russel Metals's Debt?
As you can see below, Russel Metals had CA$579.6m of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, it also had CA$98.1m in cash, and so its net debt is CA$481.5m.
A Look At Russel Metals's Liabilities
We can see from the most recent balance sheet that Russel Metals had liabilities of CA$558.0m falling due within a year, and liabilities of CA$577.7m due beyond that. Offsetting these obligations, it had cash of CA$98.1m as well as receivables valued at CA$543.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$494.1m.
While this might seem like a lot, it is not so bad since Russel Metals has a market capitalization of CA$1.27b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
With a debt to EBITDA ratio of 1.5, Russel Metals uses debt artfully but responsibly. And the alluring interest cover (EBIT of 7.4 times interest expense) certainly does not do anything to dispel this impression. Fortunately, Russel Metals grew its EBIT by 6.4% in the last year, making that debt load look even more manageable. 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 Russel Metals's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Russel Metals created free cash flow amounting to 7.4% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Our View
Russel Metals's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. But on the bright side, its ability to cover its interest expense with its EBIT isn't too shabby at all. Looking at all the angles mentioned above, it does seem to us that Russel Metals is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
