Power and Instrumentation (Guj) (NSE:PIGL) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Power and Instrumentation (Guj) Limited (NSE:PIGL) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Power and Instrumentation (Guj)

What Is Power and Instrumentation (Guj)'s Net Debt?

The chart below, which you can click on for greater detail, shows that Power and Instrumentation (Guj) had ₹215.0m in debt in September 2022; about the same as the year before. However, it does have ₹77.9m in cash offsetting this, leading to net debt of about ₹137.1m.

How Strong Is Power and Instrumentation (Guj)'s Balance Sheet?

We can see from the most recent balance sheet that Power and Instrumentation (Guj) had liabilities of ₹539.5m falling due within a year, and liabilities of ₹56.6m due beyond that. Offsetting these obligations, it had cash of ₹77.9m as well as receivables valued at ₹546.9m due within 12 months. So it actually has ₹28.7m more liquid assets than total liabilities.

This surplus suggests that Power and Instrumentation (Guj) has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Power and Instrumentation (Guj)'s net debt is sitting at a very reasonable 1.6 times its EBITDA, while its EBIT covered its interest expense just 4.6 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. One way Power and Instrumentation (Guj) could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 14%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. But it is Power and Instrumentation (Guj)'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, 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. Over the last three years, Power and Instrumentation (Guj) saw substantial negative free cash flow, in total. 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

Power and Instrumentation (Guj)'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 it has an adequate capacity to grow its EBIT. When we consider all the factors mentioned above, we do feel a bit cautious about Power and Instrumentation (Guj)'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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Power and Instrumentation (Guj) is showing 4 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.