Is Omax Autos (NSE:OMAXAUTO) Using Debt Sensibly?

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 note that Omax Autos Limited (NSE:OMAXAUTO) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Omax Autos

What Is Omax Autos's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Omax Autos had ₹1.43b of debt in March 2022, down from ₹1.71b, one year before. However, because it has a cash reserve of ₹384.8m, its net debt is less, at about ₹1.05b.

How Strong Is Omax Autos' Balance Sheet?

The latest balance sheet data shows that Omax Autos had liabilities of ₹1.38b due within a year, and liabilities of ₹1.08b falling due after that. On the other hand, it had cash of ₹384.8m and ₹230.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.85b.

Given this deficit is actually higher than the company's market capitalization of ₹1.25b, we think shareholders really should watch Omax Autos's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Omax Autos'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.

In the last year Omax Autos wasn't profitable at an EBIT level, but managed to grow its revenue by 41%, to ₹2.5b. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

While we can certainly appreciate Omax Autos's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at ₹55m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of ₹44m and the profit of ₹247m. So there is definitely a chance that it can improve things in the next few years. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Omax Autos is showing 2 warning signs in our investment analysis , 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.