Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Kabra Extrusiontechnik Limited (NSE:KABRAEXTRU) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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. 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.
How Much Debt Does Kabra Extrusiontechnik Carry?
The image below, which you can click on for greater detail, shows that Kabra Extrusiontechnik had debt of ₹239.7m at the end of March 2021, a reduction from ₹267.2m over a year. However, it does have ₹501.8m in cash offsetting this, leading to net cash of ₹262.1m.
A Look At Kabra Extrusiontechnik's Liabilities
The latest balance sheet data shows that Kabra Extrusiontechnik had liabilities of ₹1.05b due within a year, and liabilities of ₹163.4m falling due after that. Offsetting this, it had ₹501.8m in cash and ₹263.2m in receivables that were due within 12 months. So it has liabilities totalling ₹445.1m more than its cash and near-term receivables, combined.
Of course, Kabra Extrusiontechnik has a market capitalization of ₹6.21b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Kabra Extrusiontechnik boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Kabra Extrusiontechnik grew its EBIT by 547% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Kabra Extrusiontechnik's earnings that will influence how the balance sheet holds up in the future. 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. Kabra Extrusiontechnik may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Kabra Extrusiontechnik reported free cash flow worth 14% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Kabra Extrusiontechnik has ₹262.1m in net cash. And it impressed us with its EBIT growth of 547% over the last year. So we don't have any problem with Kabra Extrusiontechnik's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Kabra Extrusiontechnik (1 is a bit concerning) you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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