Simplywall.st in an opinion piece says that Steel Authority of India Limited, a prominent player in India’s steel industry, has seen its debt levels rise significantly in the past year. As of September 2024, SAIL had accumulated a staggering ₹356.1 billion in debt, up from ₹254.9 billion just a year ago. At the same time, the company’s available cash stood at ₹7.54 billion, leading to a net debt of approximately ₹348.6 billion. While debt can fuel growth and expansion, it also brings risks, particularly when the company’s ability to generate cash flow and service that debt comes into question.
Debt plays a vital role in financing business operations, especially in capital-intensive industries like steel manufacturing. For companies like SAIL, which need substantial investments in infrastructure and equipment, borrowing can be an effective way to raise capital without diluting ownership. However, the primary risk arises when a company struggles to pay back its debt. In the worst-case scenario, this could lead to bankruptcy or force the company to issue additional equity at lower prices to manage its debt burden. In SAIL’s case, the growing debt raises concerns about its future ability to service these obligations.
SAIL’s financial position shows that the company has liabilities amounting to ₹525.8 billion due within the next 12 months, with additional liabilities of ₹295.7 billion due beyond a year. On the other hand, its current assets, which include ₹7.54 billion in cash and ₹70.4 billion in receivables due within a year, are insufficient to cover its short-term obligations. This creates a significant deficit of ₹743.6 billion, placing the company in a precarious position where it might need a major recapitalization if creditors demand immediate repayment.
In evaluating how risky SAIL’s debt load is, one must look at its ability to generate earnings relative to its debt. One common measure used in this regard is the Debt to EBITDA ratio. SAIL's current debt to EBITDA ratio stands at 3.3, which indicates that the company is using debt to finance its operations, but not in an excessively risky manner. However, the company's interest coverage ratio, which measures how easily it can cover its interest expenses with its operating earnings, is just 2.4. This weak interest coverage ratio suggests that SAIL’s earnings are not sufficient to cover the interest expenses, further intensifying the risk posed by its high debt load.
Over the past year, SAIL’s earnings before interest and tax dropped by 12%, reflecting weaker operational performance. This decline in earnings raises alarms about the company’s ability to handle its debt going forward. If this downward trend continues, managing the debt could become increasingly difficult, as servicing the debt would take up a greater proportion of the company's reduced earnings. For shareholders, this may mean lower returns or even the dilution of shares to raise capital.
Another key factor in assessing debt risk is the company’s ability to generate free cash flow. While profits are important, it’s cash flow that ultimately determines whether a company can meet its debt obligations. Unfortunately for SAIL, it has recorded negative free cash flow over the past three years, which makes its debt risk even more concerning. Negative free cash flow indicates that the company is not generating enough cash from its operations to cover its expenses and reinvest in the business, making it highly reliant on external financing or further debt to stay afloat.
Given these financial indicators, it appears that SAIL's debt could become a serious burden. Although the company’s debt to EBITDA ratio suggests some capacity to manage its debt, the weak interest coverage and negative free cash flow indicate that SAIL may struggle to generate enough earnings and cash flow to meet its obligations. This situation could lead to a further deterioration in financial health, especially if the company’s earnings continue to decline.
In terms of its liabilities, SAIL’s current situation requires careful monitoring. With substantial debts due in the short term and a weak ability to generate free cash flow, the company faces a significant risk of financial instability. In the event of a sudden economic downturn or a further drop in steel prices, SAIL could find itself in a difficult position, needing to secure additional financing or restructure its debt. While debt can be a useful tool for business growth, it also exposes companies to higher risks, particularly when that debt is not supported by solid, sustainable cash flow generation.
