Does Delta Manufacturing (NSE:DELTAMAGNT) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Delta Manufacturing Limited (NSE:DELTAMAGNT) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Delta Manufacturing

How Much Debt Does Delta Manufacturing Carry?

The image below, which you can click on for greater detail, shows that Delta Manufacturing had debt of ₹472.8m at the end of September 2021, a reduction from ₹495.7m over a year. However, it does have ₹89.3m in cash offsetting this, leading to net debt of about ₹383.5m.

A Look At Delta Manufacturing's Liabilities

The latest balance sheet data shows that Delta Manufacturing had liabilities of ₹686.0m due within a year, and liabilities of ₹90.6m falling due after that. On the other hand, it had cash of ₹89.3m and ₹334.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹353.2m.

While this might seem like a lot, it is not so bad since Delta Manufacturing has a market capitalization of ₹1.15b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about Delta Manufacturing's net debt to EBITDA ratio of 4.7, we think its super-low interest cover of 0.73 times is a sign of high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. However, the silver lining was that Delta Manufacturing achieved a positive EBIT of ₹39m in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Delta Manufacturing 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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. Over the last year, Delta Manufacturing reported free cash flow worth 9.6% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

We'd go so far as to say Delta Manufacturing's interest cover was disappointing. Having said that, its ability to grow its EBIT isn't such a worry. Once we consider all the factors above, together, it seems to us that Delta Manufacturing's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. For example Delta Manufacturing has 4 warning signs (and 2 which don't sit too well with us) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.