Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Setubandhan Infrastructure Limited (NSE:SETUINFRA) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.
Check out the opportunities and risks within the IN Construction industry.
What Is Setubandhan Infrastructure's Net Debt?
The chart below, which you can click on for greater detail, shows that Setubandhan Infrastructure had ₹782.3m in debt in September 2022; about the same as the year before. Net debt is about the same, since the it doesn't have much cash.
How Healthy Is Setubandhan Infrastructure's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Setubandhan Infrastructure had liabilities of ₹1.17b due within 12 months and liabilities of ₹248.2m due beyond that. Offsetting these obligations, it had cash of ₹1.62m as well as receivables valued at ₹352.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.06b.
The deficiency here weighs heavily on the ₹242.6m 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, Setubandhan Infrastructure would likely require a major re-capitalisation if it had to pay its creditors today.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).
Setubandhan Infrastructure has a rather high debt to EBITDA ratio of 32.3 which suggests a meaningful debt load. However, its interest coverage of 4.8 is reasonably strong, which is a good sign. We also note that Setubandhan Infrastructure improved its EBIT from a last year's loss to a positive ₹11m. There's no doubt that we learn most about debt from the balance sheet. But it is Setubandhan 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Setubandhan Infrastructure actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our View
On the face of it, Setubandhan Infrastructure's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Setubandhan Infrastructure has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Setubandhan Infrastructure (at least 2 which shouldn't be ignored) , and understanding them should be part of your investment process.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.
About NSEI:SETUINFRA
Low with weak fundamentals.
