Is Jain Irrigation Systems (NSE:JISLJALEQS) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Jain Irrigation Systems Limited (NSE:JISLJALEQS) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Jain Irrigation Systems

What Is Jain Irrigation Systems's Debt?

The image below, which you can click on for greater detail, shows that Jain Irrigation Systems had debt of ₹39.7b at the end of March 2023, a reduction from ₹67.3b over a year. However, it does have ₹1.41b in cash offsetting this, leading to net debt of about ₹38.3b.

How Healthy Is Jain Irrigation Systems' Balance Sheet?

According to the last reported balance sheet, Jain Irrigation Systems had liabilities of ₹42.1b due within 12 months, and liabilities of ₹15.1b due beyond 12 months. Offsetting this, it had ₹1.41b in cash and ₹26.9b in receivables that were due within 12 months. So it has liabilities totalling ₹28.9b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of ₹39.5b, so it does suggest shareholders should keep an eye on Jain Irrigation Systems' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

As it happens Jain Irrigation Systems has a fairly concerning net debt to EBITDA ratio of 6.0 but very strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! Sadly, Jain Irrigation Systems's EBIT actually dropped 5.0% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Jain Irrigation Systems 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.

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. In the last three years, Jain Irrigation Systems's free cash flow amounted to 37% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Mulling over Jain Irrigation Systems's attempt at managing its debt, based on its EBITDA,, we're certainly not enthusiastic. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Jain Irrigation Systems stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Jain Irrigation Systems (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.