Is Bharat Road Network (NSE:BRNL) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that Bharat Road Network Limited (NSE:BRNL) 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Bharat Road Network

What Is Bharat Road Network's Net Debt?

As you can see below, Bharat Road Network had ₹14.7b of debt, at March 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had ₹2.22b in cash, and so its net debt is ₹12.5b.

A Look At Bharat Road Network's Liabilities

Zooming in on the latest balance sheet data, we can see that Bharat Road Network had liabilities of ₹6.13b due within 12 months and liabilities of ₹16.0b due beyond that. On the other hand, it had cash of ₹2.22b and ₹4.68b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹15.2b.

The deficiency here weighs heavily on the ₹3.04b 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. After all, Bharat Road Network would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Bharat Road Network shareholders face the double whammy of a high net debt to EBITDA ratio (6.8), and fairly weak interest coverage, since EBIT is just 0.76 times the interest expense. The debt burden here is substantial. The good news is that Bharat Road Network improved its EBIT by 4.3% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. There's no doubt that we learn most about debt from the balance sheet. But it is Bharat Road Network'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Bharat Road Network created free cash flow amounting to 17% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, Bharat Road Network's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. We should also note that Infrastructure industry companies like Bharat Road Network commonly do use debt without problems. Taking into account all the aforementioned factors, it looks like Bharat Road Network has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Bharat Road Network you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.
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