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 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. Importantly, United States Steel Corporation (NYSE:X) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does United States Steel Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2021 United States Steel had US$5.53b of debt, an increase on US$4.63b, over one year. On the flip side, it has US$753.0m in cash leading to net debt of about US$4.77b.
How Healthy Is United States Steel’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that United States Steel had liabilities of US$3.14b due within 12 months and liabilities of US$6.83b due beyond that. On the other hand, it had cash of US$753.0m and US$1.61b worth of receivables due within a year. So it has liabilities totalling US$7.61b more than its cash and near-term receivables, combined.
Given this deficit is actually higher than the company’s market capitalization of US$6.91b, we think shareholders really should watch United States Steel’s debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine United States Steel’s ability to maintain a healthy balance sheet going forward.
In the last year United States Steel had a loss before interest and tax, and actually shrunk its revenue by 13%, to US$11b. We would much prefer see growth.
Not only did United States Steel’s revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at US$289m. When we look at that alongside the significant liabilities, we’re not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through US$188m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet.