Power & Instrumental (Gujarat) (NSE:PIGL) Takes On Some Risk With Its Use Of Debt

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 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 Power & Instrumental (Gujarat) Limited (NSE:PIGL) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Power & Instrumental (Gujarat)

How Much Debt Does Power & Instrumental (Gujarat) Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Power & Instrumental (Gujarat) had ₹325.9m of debt, an increase on ₹215.0m, over one year. However, it also had ₹8.00m in cash, and so its net debt is ₹317.9m.

A Look At Power & Instrumental (Gujarat)'s Liabilities

Zooming in on the latest balance sheet data, we can see that Power & Instrumental (Gujarat) had liabilities of ₹545.9m due within 12 months and liabilities of ₹46.4m due beyond that. On the other hand, it had cash of ₹8.00m and ₹321.5m worth of receivables due within a year. So it has liabilities totalling ₹262.8m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Power & Instrumental (Gujarat) is worth ₹596.3m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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).

Power & Instrumental (Gujarat) has a debt to EBITDA ratio of 3.7 and its EBIT covered its interest expense 3.3 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably, Power & Instrumental (Gujarat)'s EBIT was pretty flat over the last year, which isn't ideal given the debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Power & Instrumental (Gujarat)'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 we always check how much of that EBIT is translated into free cash flow. Considering the last three years, Power & Instrumental (Gujarat) actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

We'd go so far as to say Power & Instrumental (Gujarat)'s conversion of EBIT to free cash flow was disappointing. But at least its EBIT growth rate is not so bad. Once we consider all the factors above, together, it seems to us that Power & Instrumental (Gujarat)'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. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 5 warning signs for Power & Instrumental (Gujarat) you should be aware of, and 2 of them are a bit unpleasant.

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.