Power & Instrumentation (Gujarat) (NSE:PIGL) Has A Somewhat Strained 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.' 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 can see that Power & Instrumentation (Gujarat) Limited (NSE:PIGL) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Power & Instrumentation (Gujarat)

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

The image below, which you can click on for greater detail, shows that at September 2021 Power & Instrumentation (Gujarat) had debt of ₹214.8m, up from ₹140.8m in one year. On the flip side, it has ₹60.3m in cash leading to net debt of about ₹154.5m.

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

According to the last reported balance sheet, Power & Instrumentation (Gujarat) had liabilities of ₹322.4m due within 12 months, and liabilities of ₹50.4m due beyond 12 months. Offsetting these obligations, it had cash of ₹60.3m as well as receivables valued at ₹537.5m due within 12 months. So it actually has ₹224.9m more liquid assets than total liabilities.

This surplus liquidity suggests that Power & Instrumentation (Gujarat)'s balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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 & Instrumentation (Gujarat)'s net debt is sitting at a very reasonable 2.0 times its EBITDA, while its EBIT covered its interest expense just 3.5 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Unfortunately, Power & Instrumentation (Gujarat)'s EBIT flopped 19% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Power & Instrumentation (Gujarat) will need earnings to service that debt. 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Power & Instrumentation (Gujarat) burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither Power & Instrumentation (Gujarat)'s ability to convert EBIT to free cash flow nor its EBIT growth rate gave us confidence in its ability to take on more debt. But the good news is it seems to be able to handle its total liabilities with ease. 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. 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. We've identified 4 warning signs with Power & Instrumentation (Gujarat) , and understanding them should be part of your investment process.

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.

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.

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