We Think Rail Vikas Nigam (NSE:RVNL) Is Taking Some Risk With Its Debt

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. Importantly, Rail Vikas Nigam Limited (NSE:RVNL) does carry debt. But is this debt a concern to shareholders?

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. 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. 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. 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 Rail Vikas Nigam

How Much Debt Does Rail Vikas Nigam Carry?

As you can see below, Rail Vikas Nigam had ₹64.1b of debt, at March 2023, which is about the same as the year before. You can click the chart for greater detail. However, it also had ₹18.5b in cash, and so its net debt is ₹45.5b.

How Strong Is Rail Vikas Nigam's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Rail Vikas Nigam had liabilities of ₹44.4b due within 12 months and liabilities of ₹66.6b due beyond that. Offsetting this, it had ₹18.5b in cash and ₹13.5b in receivables that were due within 12 months. So it has liabilities totalling ₹78.9b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Rail Vikas Nigam is worth ₹251.7b, 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). 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 Rail Vikas Nigam's debt to EBITDA ratio (3.6) suggests that it uses some debt, its interest cover is very weak, at 2.1, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Fortunately, Rail Vikas Nigam grew its EBIT by 5.4% in the last year, slowly shrinking its debt relative to earnings. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Rail Vikas Nigam 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Rail Vikas Nigam recorded free cash flow of 25% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Rail Vikas Nigam's interest cover was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. But on the bright side, its ability to to grow its EBIT isn't too shabby at all. Taking the abovementioned factors together we do think Rail Vikas Nigam's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. We've identified 4 warning signs with Rail Vikas Nigam (at least 3 which are concerning) , and understanding them should be part of your investment process.

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.