Is Rico Auto Industries (NSE:RICOAUTO) Using Debt Sensibly?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Rico Auto Industries Limited (NSE:RICOAUTO) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Rico Auto Industries

What Is Rico Auto Industries's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Rico Auto Industries had debt of ₹3.84b, up from ₹3.62b in one year. However, it does have ₹429.9m in cash offsetting this, leading to net debt of about ₹3.41b.

How Healthy Is Rico Auto Industries's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Rico Auto Industries had liabilities of ₹6.64b due within 12 months and liabilities of ₹2.21b due beyond that. On the other hand, it had cash of ₹429.9m and ₹3.05b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹5.36b.

Given this deficit is actually higher than the company's market capitalization of ₹4.52b, we think shareholders really should watch Rico Auto Industries's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Rico Auto Industries's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Rico Auto Industries made a loss at the EBIT level, and saw its revenue drop to ₹12b, which is a fall of 14%. We would much prefer see growth.

Caveat Emptor

Not only did Rico Auto Industries's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost ₹94m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of ₹446m over the last twelve months. So suffice it to say we consider the stock to be risky. 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. For example, we've discovered 3 warning signs for Rico Auto Industries (1 doesn't sit too well with us!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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