Is Swelect Energy Systems (NSE:SWELECTES) 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Swelect Energy Systems Limited (NSE:SWELECTES) does carry debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Swelect Energy Systems

How Much Debt Does Swelect Energy Systems Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Swelect Energy Systems had ₹2.57b of debt, an increase on ₹2.14b, over one year. But it also has ₹4.09b in cash to offset that, meaning it has ₹1.51b net cash.

A Look At Swelect Energy Systems' Liabilities

According to the last reported balance sheet, Swelect Energy Systems had liabilities of ₹2.54b due within 12 months, and liabilities of ₹855.1m due beyond 12 months. Offsetting this, it had ₹4.09b in cash and ₹513.2m in receivables that were due within 12 months. So it actually has ₹1.20b more liquid assets than total liabilities.

This surplus liquidity suggests that Swelect Energy Systems' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Swelect Energy Systems boasts net cash, so it's fair to say it does not have a heavy debt load!

Pleasingly, Swelect Energy Systems is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 482% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Swelect Energy Systems'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Swelect Energy Systems may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Swelect Energy Systems saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case Swelect Energy Systems has ₹1.51b in net cash and a decent-looking balance sheet. And we liked the look of last year's 482% year-on-year EBIT growth. So we don't have any problem with Swelect Energy Systems's use of 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. Like risks, for instance. Every company has them, and we've spotted 5 warning signs for Swelect Energy Systems (of which 1 shouldn't be ignored!) you should know about.

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. 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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