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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Om Infra Limited (NSE:OMINFRAL) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Om Infra

What Is Om Infra's Debt?

As you can see below, Om Infra had ₹1.08b of debt at March 2024, down from ₹1.47b a year prior. However, it does have ₹822.9m in cash offsetting this, leading to net debt of about ₹252.5m.

How Healthy Is Om Infra's Balance Sheet?

We can see from the most recent balance sheet that Om Infra had liabilities of ₹6.16b falling due within a year, and liabilities of ₹710.9m due beyond that. On the other hand, it had cash of ₹822.9m and ₹3.01b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹3.04b.

While this might seem like a lot, it is not so bad since Om Infra has a market capitalization of ₹12.9b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Given net debt is only 0.28 times EBITDA, it is initially surprising to see that Om Infra's EBIT has low interest coverage of 2.3 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Pleasingly, Om Infra is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 151% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Om Infra'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Om Infra burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Om Infra's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to grow its EBIT is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Om Infra's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Om Infra is showing 2 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.