Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Ausom Enterprise Limited (NSE:AUSOMENT) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Ausom Enterprise
What Is Ausom Enterprise's Net Debt?
As you can see below, Ausom Enterprise had ₹3.01b of debt at September 2020, down from ₹5.77b a year prior. On the flip side, it has ₹998.5m in cash leading to net debt of about ₹2.01b.
How Healthy Is Ausom Enterprise's Balance Sheet?
The latest balance sheet data shows that Ausom Enterprise had liabilities of ₹4.15b due within a year, and liabilities of ₹3.61m falling due after that. Offsetting this, it had ₹998.5m in cash and ₹3.46b in receivables that were due within 12 months. So it can boast ₹303.9m more liquid assets than total liabilities.
This surplus strongly suggests that Ausom Enterprise has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox.
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.
Ausom Enterprise has a rather high debt to EBITDA ratio of 5.7 which suggests a meaningful debt load. However, its interest coverage of 3.5 is reasonably strong, which is a good sign. Worse, Ausom Enterprise's EBIT was down 33% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But it is Ausom Enterprise'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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Ausom Enterprise saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
Both Ausom Enterprise's EBIT growth rate and its conversion of EBIT to free cash flow were discouraging. But at least its level of total liabilities is a gleaming silver lining to those clouds. When we consider all the factors discussed, it seems to us that Ausom Enterprise is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Ausom Enterprise (2 shouldn't be ignored) you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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About NSEI:AUSOMENT
Flawless balance sheet and good value.