Marine Electricals (India) (NSE:MARINE) Seems To Use Debt Quite Sensibly

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.' 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, Marine Electricals (India) Limited (NSE:MARINE) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Marine Electricals (India)

How Much Debt Does Marine Electricals (India) Carry?

You can click the graphic below for the historical numbers, but it shows that Marine Electricals (India) had ₹476.6m of debt in September 2020, down from ₹506.0m, one year before. However, it also had ₹78.3m in cash, and so its net debt is ₹398.3m.

How Strong Is Marine Electricals (India)'s Balance Sheet?

We can see from the most recent balance sheet that Marine Electricals (India) had liabilities of ₹1.86b falling due within a year, and liabilities of ₹146.9m due beyond that. Offsetting these obligations, it had cash of ₹78.3m as well as receivables valued at ₹2.26b due within 12 months. So it can boast ₹336.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Marine Electricals (India) could probably pay off its debt with ease, as its balance sheet is far from stretched.

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

Marine Electricals (India)'s net debt is sitting at a very reasonable 1.5 times its EBITDA, while its EBIT covered its interest expense just 6.9 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. In addition to that, we're happy to report that Marine Electricals (India) has boosted its EBIT by 43%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Marine Electricals (India)'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Marine Electricals (India) burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

The good news is that Marine Electricals (India)'s demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Marine Electricals (India) can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Marine Electricals (India) (of which 1 is a bit unpleasant!) you should know about.

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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