Here's Why Power & Instrumentation (Gujarat) (NSE:PIGL) Has A Meaningful Debt Burden

Warren Buffett famously said, '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. We note that Power & Instrumentation (Gujarat) Limited (NSE:PIGL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Power & Instrumentation (Gujarat)

What Is Power & Instrumentation (Gujarat)'s Debt?

As you can see below, at the end of March 2021, Power & Instrumentation (Gujarat) had ₹221.4m of debt, up from ₹111.8m a year ago. Click the image for more detail. However, it does have ₹62.6m in cash offsetting this, leading to net debt of about ₹158.8m.

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

The latest balance sheet data shows that Power & Instrumentation (Gujarat) had liabilities of ₹299.4m due within a year, and liabilities of ₹41.7m falling due after that. Offsetting this, it had ₹62.6m in cash and ₹434.2m in receivables that were due within 12 months. So it actually has ₹155.8m more liquid assets than total liabilities.

This surplus strongly suggests that Power & Instrumentation (Gujarat) has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Even though Power & Instrumentation (Gujarat)'s debt is only 2.2, its interest cover is really very low at 2.1. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. Unfortunately, Power & Instrumentation (Gujarat)'s EBIT flopped 12% over the last four quarters. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Power & Instrumentation (Gujarat) will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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, 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

While Power & Instrumentation (Gujarat)'s interest cover makes us cautious about it, its track record of converting EBIT to free cash flow is no better. But at least its level of total liabilities is a gleaming silver lining to those clouds. Looking at all the angles mentioned above, it does seem to us that Power & Instrumentation (Gujarat) is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Power & Instrumentation (Gujarat) (2 are potentially serious!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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