Is LGB Forge (NSE:LGBFORGE) A Risky Investment?

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 LGB Forge Limited (NSE:LGBFORGE) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for LGB Forge

What Is LGB Forge's Debt?

As you can see below, at the end of March 2022, LGB Forge had ₹133.2m of debt, up from ₹121.9m a year ago. Click the image for more detail. However, it does have ₹2.97m in cash offsetting this, leading to net debt of about ₹130.2m.

How Strong Is LGB Forge's Balance Sheet?

According to the last reported balance sheet, LGB Forge had liabilities of ₹436.1m due within 12 months, and liabilities of ₹19.8m due beyond 12 months. Offsetting these obligations, it had cash of ₹2.97m as well as receivables valued at ₹357.1m due within 12 months. So it has liabilities totalling ₹95.8m more than its cash and near-term receivables, combined.

Given LGB Forge has a market capitalization of ₹3.23b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

LGB Forge has a very low debt to EBITDA ratio of 1.4 so it is strange to see weak interest coverage, with last year's EBIT being only 2.0 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Shareholders should be aware that LGB Forge's EBIT was down 35% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since LGB Forge will need earnings to service that debt. 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 it's worth checking how much of that EBIT is backed by free cash flow. In the last two years, LGB Forge's free cash flow amounted to 23% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

While LGB Forge's interest cover makes us cautious about it, its track record of (not) growing its EBIT is no better. But its not so bad at staying on top of its total liabilities. When we consider all the factors discussed, it seems to us that LGB Forge is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for LGB Forge that you should be aware of.

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.