Is Elgi Rubber (NSE:ELGIRUBCO) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Elgi Rubber Company Limited (NSE:ELGIRUBCO) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Elgi Rubber

What Is Elgi Rubber's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Elgi Rubber had debt of ₹2.58b, up from ₹2.43b in one year. However, it does have ₹247.6m in cash offsetting this, leading to net debt of about ₹2.33b.

How Strong Is Elgi Rubber's Balance Sheet?

We can see from the most recent balance sheet that Elgi Rubber had liabilities of ₹2.15b falling due within a year, and liabilities of ₹1.24b due beyond that. On the other hand, it had cash of ₹247.6m and ₹736.3m worth of receivables due within a year. So it has liabilities totalling ₹2.41b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₹1.44b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Elgi Rubber would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is Elgi Rubber'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.

In the last year Elgi Rubber wasn't profitable at an EBIT level, but managed to grow its revenue by 14%, to ₹3.9b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Elgi Rubber had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost ₹126m 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. Not least because it had negative free cash flow of ₹28m over the last twelve months. So suffice it to say we consider the stock to be risky. 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. Case in point: We've spotted 3 warning signs for Elgi Rubber you should be aware of, and 1 of them is significant.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.