Is TVS Srichakra (NSE:TVSSRICHAK) Using Too Much Debt?

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 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. As with many other companies TVS Srichakra Limited (NSE:TVSSRICHAK) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for TVS Srichakra

What Is TVS Srichakra's Net Debt?

As you can see below, TVS Srichakra had ₹2.21b of debt at September 2020, down from ₹3.41b a year prior. However, because it has a cash reserve of ₹636.4m, its net debt is less, at about ₹1.57b.

How Healthy Is TVS Srichakra's Balance Sheet?

The latest balance sheet data shows that TVS Srichakra had liabilities of ₹4.72b due within a year, and liabilities of ₹2.80b falling due after that. On the other hand, it had cash of ₹636.4m and ₹2.38b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹4.51b.

While this might seem like a lot, it is not so bad since TVS Srichakra has a market capitalization of ₹11.6b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

TVS Srichakra has a very low debt to EBITDA ratio of 1.1 so it is strange to see weak interest coverage, with last year's EBIT being only 1.6 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Shareholders should be aware that TVS Srichakra's EBIT was down 68% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since TVS Srichakra will need earnings to service that debt. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, TVS Srichakra recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Both TVS Srichakra's EBIT growth rate and its interest cover were discouraging. But at least its conversion of EBIT to free cash flow is a gleaming silver lining to those clouds. We think that TVS Srichakra'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. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with TVS Srichakra (including 1 which is is a bit unpleasant) .

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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