We Think Ador Welding (NSE:ADORWELD) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Ador Welding Limited (NSE:ADORWELD) does carry debt. But the real question is whether this debt is making the company risky.

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Ador Welding

What Is Ador Welding's Net Debt?

As you can see below, Ador Welding had ₹476.4m of debt at September 2020, down from ₹790.9m a year prior. However, it does have ₹483.9m in cash offsetting this, leading to net cash of ₹7.50m.

How Healthy Is Ador Welding's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ador Welding had liabilities of ₹1.51b due within 12 months and liabilities of ₹78.6m due beyond that. On the other hand, it had cash of ₹483.9m and ₹1.06b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹50.2m.

This state of affairs indicates that Ador Welding's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the ₹3.65b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Ador Welding also has more cash than debt, so we're pretty confident it can manage its debt safely.

Shareholders should be aware that Ador Welding's EBIT was down 64% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Ador Welding 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Ador Welding has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Ador Welding generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

We could understand if investors are concerned about Ador Welding's liabilities, but we can be reassured by the fact it has has net cash of ₹7.50m. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in ₹455m. So we don't have any problem with Ador Welding's use of debt. 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. For instance, we've identified 3 warning signs for Ador Welding that 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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