Is Shakti Pumps (India) (NSE:SHAKTIPUMP) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Shakti Pumps (India) Limited (NSE:SHAKTIPUMP) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Shakti Pumps (India)

What Is Shakti Pumps (India)'s Net Debt?

As you can see below, Shakti Pumps (India) had ₹896.3m of debt at March 2021, down from ₹1.93b a year prior. However, it also had ₹452.2m in cash, and so its net debt is ₹444.1m.

A Look At Shakti Pumps (India)'s Liabilities

Zooming in on the latest balance sheet data, we can see that Shakti Pumps (India) had liabilities of ₹2.92b due within 12 months and liabilities of ₹375.5m due beyond that. On the other hand, it had cash of ₹452.2m and ₹2.65b worth of receivables due within a year. So its liabilities total ₹200.9m more than the combination of its cash and short-term receivables.

Having regard to Shakti Pumps (India)'s size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹13.7b company is struggling for cash, we still think it's worth monitoring its balance sheet.

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

Shakti Pumps (India) has net debt of just 0.30 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 7.9 times the interest expense over the last year. Although Shakti Pumps (India) made a loss at the EBIT level, last year, it was also good to see that it generated ₹1.3b in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Shakti Pumps (India)'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.

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 the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Shakti Pumps (India) recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Shakti Pumps (India)'s conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Looking at the bigger picture, we think Shakti Pumps (India)'s use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Shakti Pumps (India) .

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. 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.
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