Sundram Fasteners (NSE:SUNDRMFAST) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Sundram Fasteners Limited (NSE:SUNDRMFAST) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Sundram Fasteners

How Much Debt Does Sundram Fasteners Carry?

You can click the graphic below for the historical numbers, but it shows that Sundram Fasteners had ₹6.88b of debt in September 2020, down from ₹10.3b, one year before. On the flip side, it has ₹1.28b in cash leading to net debt of about ₹5.60b.

A Look At Sundram Fasteners' Liabilities

According to the last reported balance sheet, Sundram Fasteners had liabilities of ₹11.1b due within 12 months, and liabilities of ₹4.10b due beyond 12 months. On the other hand, it had cash of ₹1.28b and ₹6.67b worth of receivables due within a year. So its liabilities total ₹7.28b more than the combination of its cash and short-term receivables.

Of course, Sundram Fasteners has a market capitalization of ₹148.6b, 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.

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). 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).

With net debt sitting at just 1.0 times EBITDA, Sundram Fasteners is arguably pretty conservatively geared. And it boasts interest cover of 8.7 times, which is more than adequate. The modesty of its debt load may become crucial for Sundram Fasteners if management cannot prevent a repeat of the 25% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sundram Fasteners'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.

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. Looking at the most recent three years, Sundram Fasteners recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Sundram Fasteners's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that it has an adequate capacity to cover its interest expense with its EBIT. Looking at all this data makes us feel a little cautious about Sundram Fasteners'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. 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 instance, we've identified 2 warning signs for Sundram Fasteners that you should be aware of.

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. 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.
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