Here's Why Ratnamani Metals & Tubes (NSE:RATNAMANI) Can Manage Its Debt Responsibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Ratnamani Metals & Tubes Limited (NSE:RATNAMANI) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Ratnamani Metals & Tubes

How Much Debt Does Ratnamani Metals & Tubes Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2020 Ratnamani Metals & Tubes had ₹2.20b of debt, an increase on ₹654.0m, over one year. However, it does have ₹3.40b in cash offsetting this, leading to net cash of ₹1.20b.

How Healthy Is Ratnamani Metals & Tubes's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ratnamani Metals & Tubes had liabilities of ₹6.18b due within 12 months and liabilities of ₹2.17b due beyond that. Offsetting this, it had ₹3.40b in cash and ₹3.70b in receivables that were due within 12 months. So its liabilities total ₹1.2b more than the combination of its cash and short-term receivables.

Since publicly traded Ratnamani Metals & Tubes shares are worth a total of ₹48.1b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Ratnamani Metals & Tubes boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Ratnamani Metals & Tubes has increased its EBIT by 6.2% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is Ratnamani Metals & Tubes's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Ratnamani Metals & Tubes 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. In the last three years, Ratnamani Metals & Tubes created free cash flow amounting to 18% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Ratnamani Metals & Tubes has ₹1.20b in net cash. And it also grew its EBIT by 6.2% over the last year. So we don't have any problem with Ratnamani Metals & Tubes's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Ratnamani Metals & Tubes has 2 warning signs (and 1 which is a bit concerning) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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