Is Ratnamani Metals & Tubes (NSE:RATNAMANI) Using Too Much Debt?

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 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. We can see that Ratnamani Metals & Tubes Limited (NSE:RATNAMANI) does use debt in its business. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Ratnamani Metals & Tubes

What Is Ratnamani Metals & Tubes's Net Debt?

As you can see below, at the end of September 2020, Ratnamani Metals & Tubes had ₹1.79b of debt, up from ₹1.38b a year ago. Click the image for more detail. However, its balance sheet shows it holds ₹5.99b in cash, so it actually has ₹4.20b net cash.

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

We can see from the most recent balance sheet that Ratnamani Metals & Tubes had liabilities of ₹3.88b falling due within a year, and liabilities of ₹2.22b due beyond that. Offsetting these obligations, it had cash of ₹5.99b as well as receivables valued at ₹3.41b due within 12 months. So it can boast ₹3.30b more liquid assets than total liabilities.

This short term liquidity is a sign that Ratnamani Metals & Tubes could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Ratnamani Metals & Tubes boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Ratnamani Metals & Tubes has seen its EBIT plunge 16% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Ratnamani Metals & Tubes 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. While Ratnamani Metals & Tubes has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Ratnamani Metals & Tubes produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Ratnamani Metals & Tubes has ₹4.20b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₹3.8b, being 67% of its EBIT. So we don't have any problem with Ratnamani Metals & Tubes's use of debt. 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. To that end, you should be aware of the 1 warning sign we've spotted with Ratnamani Metals & Tubes .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

If you decide to trade Ratnamani Metals & Tubes, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all 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.