Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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?
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Prince Pipes and Fittings Carry?
The image below, which you can click on for greater detail, shows that Prince Pipes and Fittings had debt of ₹880.3m at the end of March 2021, a reduction from ₹2.48b over a year. But on the other hand it also has ₹2.33b in cash, leading to a ₹1.45b net cash position.
A Look At Prince Pipes and Fittings' Liabilities
According to the last reported balance sheet, Prince Pipes and Fittings had liabilities of ₹5.22b due within 12 months, and liabilities of ₹408.5m due beyond 12 months. On the other hand, it had cash of ₹2.33b and ₹3.62b worth of receivables due within a year. So it actually has ₹326.1m more liquid assets than total liabilities.
Having regard to Prince Pipes and Fittings' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹75.5b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Prince Pipes and Fittings has more cash than debt is arguably a good indication that it can manage its debt safely.
Better yet, Prince Pipes and Fittings grew its EBIT by 102% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Prince Pipes and Fittings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Prince Pipes and Fittings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Prince Pipes and Fittings's free cash flow amounted to 32% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Prince Pipes and Fittings has net cash of ₹1.45b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 102% over the last year. So is Prince Pipes and Fittings's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 2 warning signs for Prince Pipes and Fittings you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.
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