Does Ramky Infrastructure (NSE:RAMKY) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Ramky Infrastructure Limited (NSE:RAMKY) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Ramky Infrastructure

How Much Debt Does Ramky Infrastructure Carry?

As you can see below, at the end of September 2022, Ramky Infrastructure had ₹20.8b of debt, up from ₹7.21b a year ago. Click the image for more detail. However, because it has a cash reserve of ₹3.20b, its net debt is less, at about ₹17.6b.

How Healthy Is Ramky Infrastructure's Balance Sheet?

The latest balance sheet data shows that Ramky Infrastructure had liabilities of ₹37.1b due within a year, and liabilities of ₹5.60b falling due after that. On the other hand, it had cash of ₹3.20b and ₹3.83b worth of receivables due within a year. So its liabilities total ₹35.6b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the ₹19.8b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Ramky Infrastructure would likely require a major re-capitalisation if it had to pay its creditors today.

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). 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 Ramky Infrastructure's debt to EBITDA ratio (4.6) suggests that it uses some debt, its interest cover is very weak, at 1.4, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. However, it should be some comfort for shareholders to recall that Ramky Infrastructure actually grew its EBIT by a hefty 596%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. There's no doubt that we learn most about debt from the balance sheet. But it is Ramky Infrastructure's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. Happily for any shareholders, Ramky Infrastructure actually produced more free cash flow than EBIT over the last two years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

We feel some trepidation about Ramky Infrastructure's difficulty level of total liabilities, but we've got positives to focus on, too. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. When we consider all the factors discussed, it seems to us that Ramky Infrastructure is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Ramky Infrastructure (of which 1 is a bit unpleasant!) you should know about.

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.