Is Elgi Equipments (NSE:ELGIEQUIP) Using Too Much 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 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. As with many other companies Elgi Equipments Limited (NSE:ELGIEQUIP) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for Elgi Equipments

What Is Elgi Equipments's Net Debt?

As you can see below, Elgi Equipments had ₹4.37b of debt at March 2022, down from ₹4.67b a year prior. However, it does have ₹2.53b in cash offsetting this, leading to net debt of about ₹1.83b.

A Look At Elgi Equipments' Liabilities

Zooming in on the latest balance sheet data, we can see that Elgi Equipments had liabilities of ₹8.06b due within 12 months and liabilities of ₹1.26b due beyond that. Offsetting these obligations, it had cash of ₹2.53b as well as receivables valued at ₹4.81b due within 12 months. So its liabilities total ₹1.98b more than the combination of its cash and short-term receivables.

Having regard to Elgi Equipments' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹133.3b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, Elgi Equipments has a very light debt load indeed.

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.

Elgi Equipments has a low net debt to EBITDA ratio of only 0.57. And its EBIT covers its interest expense a whopping 463 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Elgi Equipments has boosted its EBIT by 85%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Elgi Equipments's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Elgi Equipments recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Elgi Equipments's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! Considering this range of factors, it seems to us that Elgi Equipments is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. Over time, share prices tend to follow earnings per share, so if you're interested in Elgi Equipments, you may well want to click here to check an interactive graph of its earnings per share history.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.