Is Rail Vikas Nigam (NSE:RVNL) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Rail Vikas Nigam Limited (NSE:RVNL) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Rail Vikas Nigam

How Much Debt Does Rail Vikas Nigam Carry?

As you can see below, Rail Vikas Nigam had ₹59.6b of debt at September 2023, down from ₹63.2b a year prior. However, because it has a cash reserve of ₹45.0b, its net debt is less, at about ₹14.5b.

A Look At Rail Vikas Nigam's Liabilities

We can see from the most recent balance sheet that Rail Vikas Nigam had liabilities of ₹69.3b falling due within a year, and liabilities of ₹61.0b due beyond that. On the other hand, it had cash of ₹45.0b and ₹16.1b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹69.1b.

Of course, Rail Vikas Nigam has a market capitalization of ₹379.5b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt sitting at just 1.1 times EBITDA, Rail Vikas Nigam is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 8.8 times the interest expense over the last year. On the other hand, Rail Vikas Nigam saw its EBIT drop by 2.1% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Rail Vikas Nigam can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Rail Vikas Nigam actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, Rail Vikas Nigam's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its EBIT growth rate. When we consider the range of factors above, it looks like Rail Vikas Nigam is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Rail Vikas Nigam that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.