Does Power & Instrumentation (Gujarat) (NSE:PIGL) Have A Healthy Balance Sheet?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Power & Instrumentation (Gujarat) Limited (NSE:PIGL) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Power & Instrumentation (Gujarat)

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

As you can see below, Power & Instrumentation (Gujarat) had ₹140.8m of debt at September 2020, down from ₹162.6m a year prior. However, because it has a cash reserve of ₹55.8m, its net debt is less, at about ₹85.0m.

How Strong Is Power & Instrumentation (Gujarat)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Power & Instrumentation (Gujarat) had liabilities of ₹300.1m due within 12 months and liabilities of ₹8.04m due beyond that. On the other hand, it had cash of ₹55.8m and ₹298.2m worth of receivables due within a year. So it actually has ₹45.9m more liquid assets than total liabilities.

This excess liquidity suggests that Power & Instrumentation (Gujarat) is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Given net debt is only 1.0 times EBITDA, it is initially surprising to see that Power & Instrumentation (Gujarat)'s EBIT has low interest coverage of 2.2 times. So one way or the other, it's clear the debt levels are not trivial. We saw Power & Instrumentation (Gujarat) grow its EBIT by 3.6% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. But it is Power & Instrumentation (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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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 & Instrumentation (Gujarat) recorded negative free cash flow, in total. 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

Power & Instrumentation (Gujarat)'s conversion of EBIT to free cash flow was a real negative on this analysis, as was its interest cover. But like a ballerina ending on a perfect pirouette, it has not trouble staying on top of its total liabilities. When we consider all the factors mentioned above, we do feel a bit cautious about Power & Instrumentation (Gujarat)'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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Power & Instrumentation (Gujarat) has 3 warning signs we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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