Is Pritika Auto Industries (NSE:PRITIKAUTO) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that Pritika Auto Industries Limited (NSE:PRITIKAUTO) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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.

Check out our latest analysis for Pritika Auto Industries

How Much Debt Does Pritika Auto Industries Carry?

As you can see below, at the end of September 2024, Pritika Auto Industries had ₹1.46b of debt, up from ₹1.08b a year ago. Click the image for more detail. However, it does have ₹135.4m in cash offsetting this, leading to net debt of about ₹1.33b.

How Healthy Is Pritika Auto Industries' Balance Sheet?

The latest balance sheet data shows that Pritika Auto Industries had liabilities of ₹1.43b due within a year, and liabilities of ₹790.4m falling due after that. On the other hand, it had cash of ₹135.4m and ₹374.6m worth of receivables due within a year. So it has liabilities totalling ₹1.71b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Pritika Auto Industries is worth ₹3.16b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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

Pritika Auto Industries's net debt is sitting at a very reasonable 2.4 times its EBITDA, while its EBIT covered its interest expense just 3.1 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly Pritika Auto Industries's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Pritika Auto Industries 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 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, Pritika Auto Industries 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'd go so far as to say Pritika Auto Industries's conversion of EBIT to free cash flow was disappointing. But at least its EBIT growth rate is not so bad. Looking at the bigger picture, it seems clear to us that Pritika Auto Industries'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. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Pritika Auto Industries that you should be aware of before investing here.

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.