Is Transformers and Rectifiers (India) (NSE:TRIL) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Transformers and Rectifiers (India) Limited (NSE:TRIL) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 Transformers and Rectifiers (India)

What Is Transformers and Rectifiers (India)'s Debt?

The image below, which you can click on for greater detail, shows that Transformers and Rectifiers (India) had debt of ₹2.56b at the end of March 2024, a reduction from ₹3.30b over a year. However, because it has a cash reserve of ₹69.9m, its net debt is less, at about ₹2.49b.

A Look At Transformers and Rectifiers (India)'s Liabilities

According to the last reported balance sheet, Transformers and Rectifiers (India) had liabilities of ₹5.39b due within 12 months, and liabilities of ₹660.0m due beyond 12 months. On the other hand, it had cash of ₹69.9m and ₹6.17b worth of receivables due within a year. So it actually has ₹181.3m more liquid assets than total liabilities.

Having regard to Transformers and Rectifiers (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 ₹108.8b 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Transformers and Rectifiers (India) has net debt worth 1.9 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.1 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. One way Transformers and Rectifiers (India) could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 13%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Transformers and Rectifiers (India) can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Transformers and Rectifiers (India) created free cash flow amounting to 9.4% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Transformers and Rectifiers (India)'s conversion of EBIT to free cash flow was a real negative on this analysis, as was its interest cover. Balancing that a bit, it has a demonstrated ability EBIT growth rate. Looking at all this data makes us feel a little cautious about Transformers and Rectifiers (India)'s debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Transformers and Rectifiers (India) (of which 1 is concerning!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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.

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