Is Vikas Proppant & Granite (NSE:VIKASPROP) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Vikas Proppant & Granite Limited (NSE:VIKASPROP) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Vikas Proppant & Granite

How Much Debt Does Vikas Proppant & Granite Carry?

As you can see below, Vikas Proppant & Granite had ₹572.6m of debt at March 2020, down from ₹641.9m a year prior. Net debt is about the same, since the it doesn't have much cash.

How Healthy Is Vikas Proppant & Granite's Balance Sheet?

The latest balance sheet data shows that Vikas Proppant & Granite had liabilities of ₹1.48b due within a year, and liabilities of ₹584.1m falling due after that. Offsetting these obligations, it had cash of ₹325.0k as well as receivables valued at ₹1.70b due within 12 months. So it has liabilities totalling ₹358.9m more than its cash and near-term receivables, combined.

Since publicly traded Vikas Proppant & Granite shares are worth a total of ₹1.84b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Vikas Proppant & Granite has a low net debt to EBITDA ratio of only 1.0. And its EBIT easily covers its interest expense, being 2.8k times the size. So we're pretty relaxed about its super-conservative use of debt. In fact Vikas Proppant & Granite's saving grace is its low debt levels, because its EBIT has tanked 90% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Vikas Proppant & Granite will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last two years, Vikas Proppant & Granite saw substantial negative free cash flow, in total. 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 Vikas Proppant & Granite's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Vikas Proppant & Granite stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for Vikas Proppant & Granite (1 is potentially serious!) that you should be aware of before investing here.

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.

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