Is Om Infra (NSE:OMINFRAL) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Om Infra Limited (NSE:OMINFRAL) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

See our latest analysis for Om Infra

What Is Om Infra's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Om Infra had debt of ₹1.47b, up from ₹1.30b in one year. However, it does have ₹485.6m in cash offsetting this, leading to net debt of about ₹984.2m.

A Look At Om Infra's Liabilities

Zooming in on the latest balance sheet data, we can see that Om Infra had liabilities of ₹4.46b due within 12 months and liabilities of ₹668.2m due beyond that. Offsetting these obligations, it had cash of ₹485.6m as well as receivables valued at ₹2.26b due within 12 months. So its liabilities total ₹2.38b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Om Infra has a market capitalization of ₹4.93b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Even though Om Infra's debt is only 2.0, its interest cover is really very low at 2.5. This does have us wondering if the company pays high interest because it is considered risky. Either way there's no doubt the stock is using meaningful leverage. Om Infra grew its EBIT by 4.4% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Om Infra's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last three years, Om Infra actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

On the face of it, Om Infra's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least its EBIT growth rate is not so bad. Once we consider all the factors above, together, it seems to us that Om Infra's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Om Infra has 5 warning signs (and 1 which can't be ignored) we think you should know about.

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.