Is H.G. Infra Engineering (NSE:HGINFRA) 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. We can see that H.G. Infra Engineering Limited (NSE:HGINFRA) does use debt in its business. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for H.G. Infra Engineering

What Is H.G. Infra Engineering's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 H.G. Infra Engineering had ₹14.3b of debt, an increase on ₹9.17b, over one year. On the flip side, it has ₹1.75b in cash leading to net debt of about ₹12.5b.

A Look At H.G. Infra Engineering's Liabilities

According to the last reported balance sheet, H.G. Infra Engineering had liabilities of ₹9.32b due within 12 months, and liabilities of ₹11.7b due beyond 12 months. Offsetting these obligations, it had cash of ₹1.75b as well as receivables valued at ₹9.44b due within 12 months. So it has liabilities totalling ₹9.88b more than its cash and near-term receivables, combined.

This deficit isn't so bad because H.G. Infra Engineering is worth ₹36.2b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

H.G. Infra Engineering's net debt is sitting at a very reasonable 1.7 times its EBITDA, while its EBIT covered its interest expense just 7.0 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. And we also note warmly that H.G. Infra Engineering grew its EBIT by 13% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is H.G. Infra Engineering'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, H.G. Infra Engineering saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

H.G. Infra Engineering's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its EBIT growth rate is relatively strong. Looking at all the angles mentioned above, it does seem to us that H.G. Infra Engineering is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For example - H.G. Infra Engineering has 2 warning signs we think you should be aware of.

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.