David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that Uravi T and Wedge Lamps Limited (NSE:URAVI) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. 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. 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.
What Is Uravi T and Wedge Lamps's Debt?
The chart below, which you can click on for greater detail, shows that Uravi T and Wedge Lamps had ₹226.7m in debt in March 2022; about the same as the year before. And it doesn't have much cash, so its net debt is about the same.
A Look At Uravi T and Wedge Lamps' Liabilities
According to the last reported balance sheet, Uravi T and Wedge Lamps had liabilities of ₹216.9m due within 12 months, and liabilities of ₹49.4m due beyond 12 months. Offsetting this, it had ₹661.9k in cash and ₹152.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹113.4m.
Given Uravi T and Wedge Lamps has a market capitalization of ₹1.35b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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).
While we wouldn't worry about Uravi T and Wedge Lamps's net debt to EBITDA ratio of 4.7, we think its super-low interest cover of 1.9 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. However, the silver lining was that Uravi T and Wedge Lamps achieved a positive EBIT of ₹30m in the last twelve months, an improvement on the prior year's loss. 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 Uravi T and Wedge Lamps will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. In the last year, Uravi T and Wedge Lamps's free cash flow amounted to 33% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Both Uravi T and Wedge Lamps's interest cover and its net debt to EBITDA were discouraging. But its not so bad at staying on top of its total liabilities. Looking at all the angles mentioned above, it does seem to us that Uravi T and Wedge Lamps is a somewhat risky investment as a result of its debt. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with Uravi T and Wedge Lamps (at least 2 which are concerning) , and understanding them should be part of your investment process.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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Uravi T and Wedge Lamps
Uravi T and Wedge Lamps Limited manufactures and sells lamps and electrical components for various automobile manufacturers in India.
The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.
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Proven track record with imperfect balance sheet.