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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that TimkenSteel Corporation (NYSE:TMST) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is TimkenSteel's Net Debt?
You can click the graphic below for the historical numbers, but it shows that TimkenSteel had US$44.7m of debt in June 2021, down from US$141.0m, one year before. But on the other hand it also has US$115.2m in cash, leading to a US$70.5m net cash position.
A Look At TimkenSteel's Liabilities
Zooming in on the latest balance sheet data, we can see that TimkenSteel had liabilities of US$235.7m due within 12 months and liabilities of US$257.4m due beyond that. Offsetting these obligations, it had cash of US$115.2m as well as receivables valued at US$121.3m due within 12 months. So its liabilities total US$256.6m more than the combination of its cash and short-term receivables.
TimkenSteel has a market capitalization of US$631.7m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, TimkenSteel boasts net cash, so it's fair to say it does not have a heavy debt load!
It was also good to see that despite losing money on the EBIT line last year, TimkenSteel turned things around in the last 12 months, delivering and EBIT of US$59m. When analysing debt levels, the balance sheet is the obvious place to start. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. TimkenSteel may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, TimkenSteel actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Although TimkenSteel's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$70.5m. And it impressed us with free cash flow of US$135m, being 231% of its EBIT. So we are not troubled with TimkenSteel's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with TimkenSteel , and understanding them should be part of your investment process.
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.
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.
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