These 4 Measures Indicate That Subros (NSE:SUBROS) Is Using Debt Extensively

Warren Buffett famously said, '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. As with many other companies Subros Limited (NSE:SUBROS) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Subros

What Is Subros's Net Debt?

As you can see below, Subros had ₹1.16b of debt at September 2020, down from ₹1.98b a year prior. However, it also had ₹984.0m in cash, and so its net debt is ₹174.3m.

How Healthy Is Subros' Balance Sheet?

According to the last reported balance sheet, Subros had liabilities of ₹5.30b due within 12 months, and liabilities of ₹487.7m due beyond 12 months. Offsetting these obligations, it had cash of ₹984.0m as well as receivables valued at ₹1.33b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹3.47b.

Of course, Subros has a market capitalization of ₹20.1b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. But either way, Subros has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). 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).

While Subros's low debt to EBITDA ratio of 0.15 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.8 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Importantly, Subros's EBIT fell a jaw-dropping 60% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is Subros'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Subros produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Subros's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its net debt to EBITDA was refreshing. We think that Subros's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Subros has 1 warning sign we think you should be aware of.

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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