We Think Ausom Enterprise (NSE:AUSOMENT) Is Taking Some Risk With Its Debt

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.' 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. Importantly, Ausom Enterprise Limited (NSE:AUSOMENT) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ausom Enterprise

How Much Debt Does Ausom Enterprise Carry?

As you can see below, Ausom Enterprise had ₹1.62b of debt at March 2021, down from ₹2.52b a year prior. However, because it has a cash reserve of ₹662.7m, its net debt is less, at about ₹955.6m.

How Healthy Is Ausom Enterprise's Balance Sheet?

We can see from the most recent balance sheet that Ausom Enterprise had liabilities of ₹1.94b falling due within a year, and liabilities of ₹1.95m due beyond that. Offsetting these obligations, it had cash of ₹662.7m as well as receivables valued at ₹1.66b due within 12 months. So it can boast ₹380.1m more liquid assets than total liabilities.

This luscious liquidity implies that Ausom Enterprise's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Ausom Enterprise's debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 6.0 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Shareholders should be aware that Ausom Enterprise's EBIT was down 37% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ausom Enterprise 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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Ausom Enterprise burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

While Ausom Enterprise's conversion of EBIT to free cash flow makes us cautious about it, its track record of (not) growing its EBIT is no better. But on the brighter side of life, its level of total liabilities leaves us feeling more frolicsome. Taking the abovementioned factors together we do think Ausom Enterprise's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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 example - Ausom Enterprise has 4 warning signs we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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