We Think Hi-Tech Gears (NSE:HITECHGEAR) Can Stay On Top Of 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.' 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 The Hi-Tech Gears Limited (NSE:HITECHGEAR) does have debt on its balance sheet. 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. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Hi-Tech Gears

How Much Debt Does Hi-Tech Gears Carry?

You can click the graphic below for the historical numbers, but it shows that Hi-Tech Gears had ₹2.46b of debt in September 2023, down from ₹4.26b, one year before. On the flip side, it has ₹626.5m in cash leading to net debt of about ₹1.83b.

How Strong Is Hi-Tech Gears' Balance Sheet?

According to the last reported balance sheet, Hi-Tech Gears had liabilities of ₹3.59b due within 12 months, and liabilities of ₹1.46b due beyond 12 months. Offsetting this, it had ₹626.5m in cash and ₹2.06b in receivables that were due within 12 months. So its liabilities total ₹2.35b more than the combination of its cash and short-term receivables.

Hi-Tech Gears has a market capitalization of ₹7.97b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Given net debt is only 1.3 times EBITDA, it is initially surprising to see that Hi-Tech Gears's EBIT has low interest coverage of 2.0 times. So one way or the other, it's clear the debt levels are not trivial. It is well worth noting that Hi-Tech Gears's EBIT shot up like bamboo after rain, gaining 78% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hi-Tech Gears 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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Hi-Tech Gears's free cash flow amounted to 39% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

When it comes to the balance sheet, the standout positive for Hi-Tech Gears was the fact that it seems able to grow its EBIT confidently. However, our other observations weren't so heartening. In particular, interest cover gives us cold feet. When we consider all the elements mentioned above, it seems to us that Hi-Tech Gears is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. For example Hi-Tech Gears has 4 warning signs (and 1 which can't be ignored) we think you should know about.

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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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.