Somi Conveyor Beltings (NSE:SOMICONVEY) Has A Rock Solid Balance Sheet

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. As with many other companies Somi Conveyor Beltings Limited (NSE:SOMICONVEY) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Somi Conveyor Beltings

What Is Somi Conveyor Beltings's Debt?

The image below, which you can click on for greater detail, shows that Somi Conveyor Beltings had debt of ₹158.4m at the end of September 2023, a reduction from ₹210.3m over a year. However, because it has a cash reserve of ₹69.2m, its net debt is less, at about ₹89.3m.

How Healthy Is Somi Conveyor Beltings' Balance Sheet?

We can see from the most recent balance sheet that Somi Conveyor Beltings had liabilities of ₹335.0m falling due within a year, and liabilities of ₹18.3m due beyond that. Offsetting this, it had ₹69.2m in cash and ₹300.5m in receivables that were due within 12 months. So it can boast ₹16.4m more liquid assets than total liabilities.

Having regard to Somi Conveyor Beltings' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹1.43b company is short on cash, but still worth keeping an eye on the balance sheet.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

With net debt sitting at just 1.0 times EBITDA, Somi Conveyor Beltings is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 7.4 times the interest expense over the last year. In addition to that, we're happy to report that Somi Conveyor Beltings has boosted its EBIT by 31%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is Somi Conveyor Beltings'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Somi Conveyor Beltings recorded free cash flow worth a fulsome 90% 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

Somi Conveyor Beltings'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 EBIT growth rate is also very heartening. Overall, we don't think Somi Conveyor Beltings is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. 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. Case in point: We've spotted 1 warning sign for Somi Conveyor Beltings you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.