Is Delta Manufacturing (NSE:DELTAMAGNT) Using Too Much Debt?

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 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. We note that Delta Manufacturing Limited (NSE:DELTAMAGNT) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Delta Manufacturing

What Is Delta Manufacturing's Debt?

The image below, which you can click on for greater detail, shows that Delta Manufacturing had debt of ₹474.0m at the end of September 2020, a reduction from ₹579.9m over a year. However, it does have ₹70.6m in cash offsetting this, leading to net debt of about ₹403.4m.

How Strong Is Delta Manufacturing's Balance Sheet?

According to the last reported balance sheet, Delta Manufacturing had liabilities of ₹886.9m due within 12 months, and liabilities of ₹72.8m due beyond 12 months. On the other hand, it had cash of ₹70.6m and ₹288.4m worth of receivables due within a year. So its liabilities total ₹600.7m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the ₹314.7m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Delta Manufacturing would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Delta Manufacturing's earnings that will influence how the balance sheet holds up in the future. 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.

Over 12 months, Delta Manufacturing reported revenue of ₹1.0b, which is a gain of 29%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Despite the top line growth, Delta Manufacturing still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable ₹103m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of ₹162m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. 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. Case in point: We've spotted 4 warning signs for Delta Manufacturing you should be aware of, and 3 of them don't sit too well with us.

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. 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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