Here's Why Capacit'e Infraprojects (NSE:CAPACITE) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Capacit'e Infraprojects Limited (NSE:CAPACITE) does carry debt. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Capacit'e Infraprojects

How Much Debt Does Capacit'e Infraprojects Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Capacit'e Infraprojects had ₹3.35b of debt, an increase on ₹2.49b, over one year. On the flip side, it has ₹1.84b in cash leading to net debt of about ₹1.51b.

A Look At Capacit'e Infraprojects' Liabilities

Zooming in on the latest balance sheet data, we can see that Capacit'e Infraprojects had liabilities of ₹10.1b due within 12 months and liabilities of ₹4.06b due beyond that. On the other hand, it had cash of ₹1.84b and ₹9.09b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹3.25b.

Capacit'e Infraprojects has a market capitalization of ₹12.5b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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).

Capacit'e Infraprojects has a very low debt to EBITDA ratio of 0.59 so it is strange to see weak interest coverage, with last year's EBIT being only 2.1 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Importantly, Capacit'e Infraprojects grew its EBIT by 45% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Capacit'e Infraprojects'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Considering the last three years, Capacit'e Infraprojects actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On our analysis Capacit'e Infraprojects's EBIT growth rate should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. In particular, interest cover gives us cold feet. Looking at all this data makes us feel a little cautious about Capacit'e Infraprojects's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Capacit'e Infraprojects that you should be aware of before investing here.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.