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.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. We note that Nucor Corporation (NYSE:NUE) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Nucor’s Debt?
The image below, which you can click on for greater detail, shows that Nucor had debt of US$6.83b at the end of July 2023, a reduction from US$7.54b over a year. However, it does have US$5.38b in cash offsetting this, leading to net debt of about US$1.45b.
How Healthy Is Nucor’s Balance Sheet?
According to the last reported balance sheet, Nucor had liabilities of US$4.00b due within 12 months, and liabilities of US$8.43b due beyond 12 months. On the other hand, it had cash of US$5.38b and US$3.87b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.18b.
Of course, Nucor has a titanic market capitalization of US$38.1b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Nucor’s net debt is only 0.16 times its EBITDA. And its EBIT covers its interest expense a whopping 90.3 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In fact Nucor’s saving grace is its low debt levels, because its EBIT has tanked 39% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Nucor can strengthen its balance sheet over time.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Nucor recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
Based on what we’ve seen Nucor is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the elements mentioned above, it seems to us that Nucor is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There’s no doubt that we learn most about debt from the balance sheet.