Prince Pipes and Fittings (NSE:PRINCEPIPE) Has A Somewhat Strained Balance Sheet

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. Importantly, Prince Pipes and Fittings Limited (NSE:PRINCEPIPE) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Prince Pipes and Fittings

What Is Prince Pipes and Fittings's Net Debt?

The image below, which you can click on for greater detail, shows that Prince Pipes and Fittings had debt of ₹1.40b at the end of September 2022, a reduction from ₹1.61b over a year. However, it does have ₹1.21b in cash offsetting this, leading to net debt of about ₹188.9m.

How Healthy Is Prince Pipes and Fittings' Balance Sheet?

We can see from the most recent balance sheet that Prince Pipes and Fittings had liabilities of ₹4.53b falling due within a year, 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 outweigh the sum of its cash and (near-term) receivables by ₹216.0m.

This state of affairs indicates that Prince Pipes and Fittings' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the ₹59.4b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, Prince Pipes and Fittings has a very light debt load indeed.

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.

With debt at a measly 0.079 times EBITDA and EBIT covering interest a whopping 27.3 times, it's clear that Prince Pipes and Fittings is not a desperate borrower. So relative to past earnings, the debt load seems trivial. In fact Prince Pipes and Fittings's saving grace is its low debt levels, because its EBIT has tanked 55% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Prince Pipes and Fittings 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Prince Pipes and Fittings recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

While Prince Pipes and Fittings's EBIT growth rate has us nervous. To wit both its interest cover and net debt to EBITDA were encouraging signs. We think that Prince Pipes and Fittings's debt does make it a bit risky, after considering the aforementioned data points together. 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. For instance, we've identified 2 warning signs for Prince Pipes and Fittings that you should be aware of.

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.