These 4 Measures Indicate That Synergy Green Industries (NSE:SGIL) Is Using Debt Reasonably Well

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.' 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. We can see that Synergy Green Industries Limited (NSE:SGIL) 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. If things get really bad, the lenders can take control of the business. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Synergy Green Industries

What Is Synergy Green Industries's Debt?

You can click the graphic below for the historical numbers, but it shows that Synergy Green Industries had ₹772.7m of debt in September 2023, down from ₹1.06b, one year before. On the flip side, it has ₹59.8m in cash leading to net debt of about ₹712.9m.

How Healthy Is Synergy Green Industries' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Synergy Green Industries had liabilities of ₹1.10b due within 12 months and liabilities of ₹399.2m due beyond that. Offsetting these obligations, it had cash of ₹59.8m as well as receivables valued at ₹358.6m due within 12 months. So it has liabilities totalling ₹1.08b more than its cash and near-term receivables, combined.

Synergy Green Industries has a market capitalization of ₹5.20b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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 Synergy Green Industries has a quite reasonable net debt to EBITDA multiple of 1.9, its interest cover seems weak, at 2.1. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. Notably, Synergy Green Industries's EBIT launched higher than Elon Musk, gaining a whopping 133% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Synergy Green Industries 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Synergy Green Industries produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, Synergy Green Industries's impressive EBIT growth rate implies it has the upper hand on its debt. But the stark truth is that we are concerned by its interest cover. All these things considered, it appears that Synergy Green Industries can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. Be aware that Synergy Green Industries is showing 3 warning signs in our investment analysis , and 2 of those are significant...

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.