Sandhar Technologies (NSE:SANDHAR) Has A Pretty 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.' 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 Sandhar Technologies Limited (NSE:SANDHAR) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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.

What Is Sandhar Technologies's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Sandhar Technologies had debt of ₹7.31b, up from ₹6.68b in one year. On the flip side, it has ₹756.8m in cash leading to net debt of about ₹6.55b.

How Healthy Is Sandhar Technologies' Balance Sheet?

The latest balance sheet data shows that Sandhar Technologies had liabilities of ₹10.2b due within a year, and liabilities of ₹3.87b falling due after that. Offsetting these obligations, it had cash of ₹756.8m as well as receivables valued at ₹4.03b due within 12 months. So its liabilities total ₹9.28b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Sandhar Technologies has a market capitalization of ₹23.3b, 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.

See our latest analysis for Sandhar Technologies

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Sandhar Technologies has net debt worth 1.8 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 4.0 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Also relevant is that Sandhar Technologies has grown its EBIT by a very respectable 25% in the last year, thus enhancing its ability to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sandhar Technologies can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. In the last three years, Sandhar Technologies created free cash flow amounting to 10.0% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

When it comes to the balance sheet, the standout positive for Sandhar Technologies was the fact that it seems able to grow its EBIT confidently. But the other factors we noted above weren't so encouraging. For example, its conversion of EBIT to free cash flow makes us a little nervous about its debt. Looking at all this data makes us feel a little cautious about Sandhar Technologies's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Sandhar Technologies that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.