We Think Bharat Wire Ropes (NSE:BHARATWIRE) Is Taking Some Risk With Its Debt

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 Wire Ropes Limited (NSE:BHARATWIRE) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Bharat Wire Ropes

What Is Bharat Wire Ropes's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2020 Bharat Wire Ropes had ₹6.74b of debt, an increase on ₹6.10b, over one year. Net debt is about the same, since the it doesn't have much cash.

How Healthy Is Bharat Wire Ropes's Balance Sheet?

According to the last reported balance sheet, Bharat Wire Ropes had liabilities of ₹4.30b due within 12 months, and liabilities of ₹2.83b due beyond 12 months. Offsetting this, it had ₹33.1m in cash and ₹295.9m in receivables that were due within 12 months. So its liabilities total ₹6.80b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the ₹1.08b 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 Wire Ropes 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Bharat Wire Ropes shareholders face the double whammy of a high net debt to EBITDA ratio (23.5), and fairly weak interest coverage, since EBIT is just 0.072 times the interest expense. The debt burden here is substantial. However, the silver lining was that Bharat Wire Ropes achieved a positive EBIT of ₹66m in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Bharat Wire Ropes's earnings that will influence how the balance sheet holds up in the future. 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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Bharat Wire Ropes actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, Bharat Wire Ropes'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. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. We're quite clear that we consider Bharat Wire Ropes to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Bharat Wire Ropes is showing 3 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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