Isgec Heavy Engineering (NSE:ISGEC) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Isgec Heavy Engineering Limited (NSE:ISGEC) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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.

See our latest analysis for Isgec Heavy Engineering

What Is Isgec Heavy Engineering's Debt?

You can click the graphic below for the historical numbers, but it shows that Isgec Heavy Engineering had ₹6.93b of debt in September 2024, down from ₹9.33b, one year before. However, it also had ₹2.75b in cash, and so its net debt is ₹4.18b.

How Healthy Is Isgec Heavy Engineering's Balance Sheet?

The latest balance sheet data shows that Isgec Heavy Engineering had liabilities of ₹41.6b due within a year, and liabilities of ₹6.80b falling due after that. Offsetting this, it had ₹2.75b in cash and ₹25.9b in receivables that were due within 12 months. So it has liabilities totalling ₹19.8b more than its cash and near-term receivables, combined.

Since publicly traded Isgec Heavy Engineering shares are worth a total of ₹100.5b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). 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).

Isgec Heavy Engineering has a low net debt to EBITDA ratio of only 0.78. And its EBIT easily covers its interest expense, being 13.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that Isgec Heavy Engineering saw its EBIT decline by 3.2% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Isgec Heavy Engineering's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Isgec Heavy Engineering recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Isgec Heavy Engineering's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its EBIT growth rate does undermine this impression a bit. All these things considered, it appears that Isgec Heavy Engineering can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Isgec Heavy Engineering that you should be aware of before investing here.

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.