These 4 Measures Indicate That Om Infra (NSE:OMINFRAL) Is Using Debt Extensively

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. Importantly, Om Infra Limited (NSE:OMINFRAL) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out 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 March 2021 Om Infra had debt of ₹1.28b, up from ₹1.13b in one year. On the flip side, it has ₹466.8m in cash leading to net debt of about ₹812.1m.

How Healthy Is Om Infra's Balance Sheet?

According to the last reported balance sheet, Om Infra had liabilities of ₹4.54b due within 12 months, and liabilities of ₹790.1m due beyond 12 months. Offsetting this, it had ₹466.8m in cash and ₹1.78b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹3.08b.

Given this deficit is actually higher than the company's market capitalization of ₹3.02b, we think shareholders really should watch Om Infra's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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).

While Om Infra has a quite reasonable net debt to EBITDA multiple of 1.7, its interest cover seems weak, at 1.6. This does have us wondering if the company pays high interest because it is considered risky. In any case, it's safe to say the company has meaningful debt. Notably, Om Infra's EBIT launched higher than Elon Musk, gaining a whopping 308% on last year. When analysing debt levels, the balance sheet is the obvious place to start. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Om Infra saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

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 on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. 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. 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. Case in point: We've spotted 4 warning signs for Om Infra you should be aware of, and 1 of them makes us a bit uncomfortable.

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. 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.
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