Is Energy-Mission Machineries (India) (NSE:EMMIL) 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 can see that Energy-Mission Machineries (India) Limited (NSE:EMMIL) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Energy-Mission Machineries (India)

How Much Debt Does Energy-Mission Machineries (India) Carry?

You can click the graphic below for the historical numbers, but it shows that Energy-Mission Machineries (India) had ₹207.6m of debt in September 2024, down from ₹324.4m, one year before. However, it also had ₹87.9m in cash, and so its net debt is ₹119.7m.

How Healthy Is Energy-Mission Machineries (India)'s Balance Sheet?

The latest balance sheet data shows that Energy-Mission Machineries (India) had liabilities of ₹457.8m due within a year, and liabilities of ₹74.0m falling due after that. On the other hand, it had cash of ₹87.9m and ₹171.0m worth of receivables due within a year. So its liabilities total ₹272.9m more than the combination of its cash and short-term receivables.

Given Energy-Mission Machineries (India) has a market capitalization of ₹3.20b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt sitting at just 0.59 times EBITDA, Energy-Mission Machineries (India) is arguably pretty conservatively geared. And it boasts interest cover of 7.7 times, which is more than adequate. Also positive, Energy-Mission Machineries (India) grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Energy-Mission Machineries (India) will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Energy-Mission Machineries (India) barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Our View

The good news is that Energy-Mission Machineries (India)'s demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. All these things considered, it appears that Energy-Mission Machineries (India) can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Energy-Mission Machineries (India) that you should be aware of.

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.