These 4 Measures Indicate That Power & Instrumentation (Gujarat) (NSE:PIGL) Is Using Debt Extensively

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Power & Instrumentation (Gujarat) Limited (NSE:PIGL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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.

View our latest analysis for Power & Instrumentation (Gujarat)

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

As you can see below, at the end of March 2022, Power & Instrumentation (Gujarat) had ₹284.8m of debt, up from ₹221.4m a year ago. Click the image for more detail. On the flip side, it has ₹69.2m in cash leading to net debt of about ₹215.5m.

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 ₹552.6m due within 12 months and liabilities of ₹48.6m due beyond that. On the other hand, it had cash of ₹69.2m and ₹625.4m worth of receivables due within a year. So it actually has ₹93.4m more liquid assets than total liabilities.

This surplus suggests that Power & Instrumentation (Gujarat) is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders.

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

Power & Instrumentation (Gujarat) has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 2.8 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Notably, Power & Instrumentation (Gujarat)'s EBIT was pretty flat over the last year, which isn't ideal given the debt load. 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 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) saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Power & Instrumentation (Gujarat)'s struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its level of total liabilities was refreshing. 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. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Power & Instrumentation (Gujarat) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.