Does Hi-Tech Gears (NSE:HITECHGEAR) Have A Healthy Balance Sheet?

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.' 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 The Hi-Tech Gears Limited (NSE:HITECHGEAR) does use debt in its business. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Hi-Tech Gears

What Is Hi-Tech Gears's Debt?

As you can see below, Hi-Tech Gears had ₹4.33b of debt, at March 2023, which is about the same as the year before. You can click the chart for greater detail. However, it also had ₹798.5m in cash, and so its net debt is ₹3.53b.

How Strong Is Hi-Tech Gears' Balance Sheet?

According to the last reported balance sheet, Hi-Tech Gears had liabilities of ₹3.84b due within 12 months, and liabilities of ₹2.48b due beyond 12 months. On the other hand, it had cash of ₹798.5m and ₹2.12b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹3.39b.

While this might seem like a lot, it is not so bad since Hi-Tech Gears has a market capitalization of ₹6.03b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

While Hi-Tech Gears has a quite reasonable net debt to EBITDA multiple of 2.4, its interest cover seems weak, at 2.0. The main reason for this is that it has such high depreciation and amortisation. These charges may be non-cash, so they could be excluded when it comes to paying down debt. But the accounting charges are there for a reason -- some assets are seen to be losing value. Either way there's no doubt the stock is using meaningful leverage. Pleasingly, Hi-Tech Gears is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 121% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Hi-Tech Gears'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, Hi-Tech Gears actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Neither Hi-Tech Gears's ability to cover its interest expense with its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Hi-Tech Gears's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Hi-Tech Gears has 4 warning signs (and 2 which make us uncomfortable) we think you should know about.

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.