PNC Infratech (NSE:PNCINFRA) Takes On Some Risk With Its Use Of Debt

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. As with many other companies PNC Infratech Limited (NSE:PNCINFRA) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for PNC Infratech

How Much Debt Does PNC Infratech Carry?

As you can see below, at the end of September 2020, PNC Infratech had ₹35.2b of debt, up from ₹27.6b a year ago. Click the image for more detail. On the flip side, it has ₹13.5b in cash leading to net debt of about ₹21.7b.

How Healthy Is PNC Infratech's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that PNC Infratech had liabilities of ₹13.8b due within 12 months and liabilities of ₹47.7b due beyond that. Offsetting this, it had ₹13.5b in cash and ₹8.27b in receivables that were due within 12 months. So its liabilities total ₹39.7b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of ₹43.9b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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).

While PNC Infratech has a quite reasonable net debt to EBITDA multiple of 1.8, its interest cover seems weak, at 2.0. This does suggest the company is paying fairly high interest rates. Either way there's no doubt the stock is using meaningful leverage. Sadly, PNC Infratech's EBIT actually dropped 5.3% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if PNC Infratech can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, PNC Infratech created free cash flow amounting to 18% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

We'd go so far as to say PNC Infratech's interest cover was disappointing. But at least its net debt to EBITDA is not so bad. Looking at the bigger picture, it seems clear to us that PNC Infratech's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. Case in point: We've spotted 2 warning signs for PNC Infratech you should be aware of, and 1 of them is a bit unpleasant.

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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