Does Sundaram-Clayton (NSE:SUNCLAYLTD) Have A Healthy Balance Sheet?

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, Sundaram-Clayton Limited (NSE:SUNCLAYLTD) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Sundaram-Clayton

How Much Debt Does Sundaram-Clayton Carry?

As you can see below, at the end of September 2020, Sundaram-Clayton had ₹125.7b of debt, up from ₹107.0b a year ago. Click the image for more detail. However, it does have ₹19.3b in cash offsetting this, leading to net debt of about ₹106.3b.

A Look At Sundaram-Clayton's Liabilities

According to the last reported balance sheet, Sundaram-Clayton had liabilities of ₹112.4b due within 12 months, and liabilities of ₹66.1b due beyond 12 months. Offsetting this, it had ₹19.3b in cash and ₹68.1b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹91.0b.

The deficiency here weighs heavily on the ₹35.5b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Sundaram-Clayton would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Sundaram-Clayton shareholders face the double whammy of a high net debt to EBITDA ratio (5.8), and fairly weak interest coverage, since EBIT is just 1.5 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, Sundaram-Clayton saw its EBIT tank 28% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sundaram-Clayton's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Sundaram-Clayton 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

On the face of it, Sundaram-Clayton's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its net debt to EBITDA fails to inspire much confidence. Considering everything we've mentioned above, it's fair to say that Sundaram-Clayton is carrying heavy debt load. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Sundaram-Clayton (at least 2 which make us uncomfortable) , and understanding them should be part of your investment process.

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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