Here's Why Rail Vikas Nigam (NSE:RVNL) Can Manage Its Debt Responsibly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Rail Vikas Nigam Limited (NSE:RVNL) makes use of debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Rail Vikas Nigam

What Is Rail Vikas Nigam's Net Debt?

The image below, which you can click on for greater detail, shows that Rail Vikas Nigam had debt of ₹59.9b at the end of March 2024, a reduction from ₹64.1b over a year. However, because it has a cash reserve of ₹31.1b, its net debt is less, at about ₹28.8b.

How Healthy Is Rail Vikas Nigam's Balance Sheet?

We can see from the most recent balance sheet that Rail Vikas Nigam had liabilities of ₹45.8b falling due within a year, and liabilities of ₹62.9b due beyond that. Offsetting these obligations, it had cash of ₹31.1b as well as receivables valued at ₹15.5b due within 12 months. So it has liabilities totalling ₹62.0b more than its cash and near-term receivables, combined.

Given Rail Vikas Nigam has a market capitalization of ₹779.7b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

While Rail Vikas Nigam's low debt to EBITDA ratio of 1.1 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.4 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Pleasingly, Rail Vikas Nigam is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 106% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Rail Vikas Nigam can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Rail Vikas Nigam recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Rail Vikas Nigam's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its interest cover. Looking at the bigger picture, we think Rail Vikas Nigam's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Rail Vikas Nigam 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.