Reliance Steel & Aluminum (NYSE:RS) Has A Pretty Healthy Balance Sheet

Stock Analysis

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Reliance Steel & Aluminum Co. (NYSE:RS) does carry debt. But should shareholders be worried about its use of debt?

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, 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.

Check out our latest analysis for Reliance Steel & Aluminum

As you can see below, Reliance Steel & Aluminum had US$1.14b of debt at June 2023, down from US$1.65b a year prior. On the flip side, it has US$816.3m in cash leading to net debt of about US$324.9m.

Zooming in on the latest balance sheet data, we can see that Reliance Steel & Aluminum had liabilities of US$937.8m due within 12 months and liabilities of US$1.88b due beyond that. Offsetting this, it had US$816.3m in cash and US$1.73b in receivables that were due within 12 months. So it has liabilities totalling US$268.7m more than its cash and near-term receivables, combined.

This state of affairs indicates that Reliance Steel & Aluminum's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$16.3b company is struggling for cash, we still think it's worth monitoring its balance sheet.

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.

Reliance Steel & Aluminum has a low net debt to EBITDA ratio of only 0.14. And its EBIT covers its interest expense a whopping 39.2 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. It is just as well that Reliance Steel & Aluminum's load is not too heavy, because its EBIT was down 23% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Reliance Steel & Aluminum can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Reliance Steel & Aluminum produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Reliance Steel & Aluminum's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Considering this range of data points, we think Reliance Steel & Aluminum is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Case in point: We've spotted 2 warning signs for Reliance Steel & Aluminum you should be aware of, and 1 of them is a bit unpleasant.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Find out whether Reliance Steel & Aluminum is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.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.

Reliance Steel & Aluminum Co. operates as a diversified metal solutions provider and the metals service center company in the United States, Canada, and internationally.

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