Here's Why Shigan Quantum Technologies (NSE:SHIGAN) Can Manage Its Debt Responsibly

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 can see that Shigan Quantum Technologies Limited (NSE:SHIGAN) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Shigan Quantum Technologies

What Is Shigan Quantum Technologies's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Shigan Quantum Technologies had debt of ₹507.9m, up from ₹377.2m in one year. However, because it has a cash reserve of ₹80.2m, its net debt is less, at about ₹427.7m.

How Healthy Is Shigan Quantum Technologies' Balance Sheet?

We can see from the most recent balance sheet that Shigan Quantum Technologies had liabilities of ₹785.7m falling due within a year, and liabilities of ₹100.9m due beyond that. On the other hand, it had cash of ₹80.2m and ₹737.7m worth of receivables due within a year. So its liabilities total ₹68.7m more than the combination of its cash and short-term receivables.

Of course, Shigan Quantum Technologies has a market capitalization of ₹2.33b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Shigan Quantum Technologies has net debt worth 2.3 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.0 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. Pleasingly, Shigan Quantum Technologies is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 191% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shigan Quantum Technologies'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. During the last three years, Shigan Quantum Technologies burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Shigan Quantum Technologies's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its EBIT growth rate. Looking at all this data makes us feel a little cautious about Shigan Quantum Technologies's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Shigan Quantum Technologies is showing 6 warning signs in our investment analysis , and 3 of those are potentially serious...

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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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.