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.' 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. We can see that SML Isuzu Limited (NSE:SMLISUZU) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is SML Isuzu's Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2021 SML Isuzu had ₹2.07b of debt, an increase on ₹1.75b, over one year. However, it does have ₹374.1m in cash offsetting this, leading to net debt of about ₹1.69b.
How Healthy Is SML Isuzu's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that SML Isuzu had liabilities of ₹4.42b due within 12 months and liabilities of ₹990.8m due beyond that. On the other hand, it had cash of ₹374.1m and ₹403.7m worth of receivables due within a year. So it has liabilities totalling ₹4.63b more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of ₹6.46b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But it is SML Isuzu's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year SML Isuzu had a loss before interest and tax, and actually shrunk its revenue by 48%, to ₹6.0b. To be frank that doesn't bode well.
While SML Isuzu's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable ₹1.1b at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through ₹662m of cash over the last year. So suffice it to say we consider the stock very risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for SML Isuzu (of which 2 shouldn't be ignored!) you should know about.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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