Here's Why Sanghi Industries (NSE:SANGHIIND) Is Weighed Down By Its Debt Load

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. As with many other companies Sanghi Industries Limited (NSE:SANGHIIND) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.

Check out our latest analysis for Sanghi Industries

What Is Sanghi Industries's Debt?

As you can see below, at the end of September 2020, Sanghi Industries had ₹11.7b of debt, up from ₹10.3b a year ago. Click the image for more detail. On the flip side, it has ₹594.4m in cash leading to net debt of about ₹11.1b.

A Look At Sanghi Industries's Liabilities

According to the last reported balance sheet, Sanghi Industries had liabilities of ₹8.01b due within 12 months, and liabilities of ₹10.3b due beyond 12 months. Offsetting these obligations, it had cash of ₹594.4m as well as receivables valued at ₹390.4m due within 12 months. So it has liabilities totalling ₹17.3b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the ₹7.81b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Sanghi Industries would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 1.4 times and a disturbingly high net debt to EBITDA ratio of 6.9 hit our confidence in Sanghi Industries like a one-two punch to the gut. The debt burden here is substantial. Worse, Sanghi Industries's EBIT was down 20% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sanghi Industries will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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, Sanghi Industries burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Sanghi Industries's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And furthermore, its net debt to EBITDA also fails to instill confidence. It looks to us like Sanghi Industries carries a significant balance sheet burden. If you play with fire you risk getting burnt, so we'd probably give this stock a wide berth. 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. For instance, we've identified 3 warning signs for Sanghi Industries (1 is concerning) you should be aware of.

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.

If you’re looking to trade Sanghi Industries, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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