Is Prince Pipes and Fittings (NSE:PRINCEPIPE) Using Too Much 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.' 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. As with many other companies Prince Pipes and Fittings Limited (NSE:PRINCEPIPE) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Prince Pipes and Fittings

What Is Prince Pipes and Fittings's Debt?

As you can see below, Prince Pipes and Fittings had ₹1.34b of debt at September 2022, down from ₹1.59b a year prior. However, it also had ₹1.21b in cash, and so its net debt is ₹125.4m.

How Strong Is Prince Pipes and Fittings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Prince Pipes and Fittings had liabilities of ₹4.53b due within 12 months and liabilities of ₹263.8m due beyond that. On the other hand, it had cash of ₹1.21b and ₹3.37b worth of receivables due within a year. So its liabilities total ₹216.0m more than the combination of its cash and short-term receivables.

Having regard to Prince Pipes and Fittings' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹64.4b company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, Prince Pipes and Fittings has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Prince Pipes and Fittings has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.044 and EBIT of 26.7 times the interest expense. Indeed relative to its earnings its debt load seems light as a feather. It is just as well that Prince Pipes and Fittings's load is not too heavy, because its EBIT was down 41% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Prince Pipes and Fittings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last three years, Prince Pipes and Fittings 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

We feel some trepidation about Prince Pipes and Fittings's difficulty EBIT growth rate, but we've got positives to focus on, too. To wit both its interest cover and net debt to EBITDA were encouraging signs. Looking at all the angles mentioned above, it does seem to us that Prince Pipes and Fittings 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. We've identified 2 warning signs with Prince Pipes and Fittings , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.