KNR Constructions (NSE:KNRCON) Has A Pretty Healthy Balance Sheet

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, KNR Constructions Limited (NSE:KNRCON) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for KNR Constructions

How Much Debt Does KNR Constructions Carry?

You can click the graphic below for the historical numbers, but it shows that KNR Constructions had ₹7.68b of debt in September 2023, down from ₹19.0b, one year before. However, it also had ₹929.8m in cash, and so its net debt is ₹6.75b.

How Strong Is KNR Constructions' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that KNR Constructions had liabilities of ₹10.0b due within 12 months and liabilities of ₹6.26b due beyond that. On the other hand, it had cash of ₹929.8m and ₹1.95b worth of receivables due within a year. So its liabilities total ₹13.4b more than the combination of its cash and short-term receivables.

Given KNR Constructions has a market capitalization of ₹74.1b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

KNR Constructions's net debt is only 0.75 times its EBITDA. And its EBIT covers its interest expense a whopping 10.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that KNR Constructions has increased its EBIT by 2.5% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine KNR Constructions's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, KNR Constructions created free cash flow amounting to 16% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Both KNR Constructions's ability to to cover its interest expense with its EBIT and its net debt to EBITDA gave us comfort that it can handle its debt. On the other hand, its conversion of EBIT to free cash flow makes us a little less comfortable about its debt. Considering this range of data points, we think KNR Constructions is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with KNR Constructions .

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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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.