Veto Switchgears and Cables (NSE:VETO) Seems To Use Debt Quite Sensibly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Veto Switchgears and Cables Limited (NSE:VETO) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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, 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.

View our latest analysis for Veto Switchgears and Cables

How Much Debt Does Veto Switchgears and Cables Carry?

As you can see below, Veto Switchgears and Cables had ₹472.2m of debt at September 2023, down from ₹516.1m a year prior. On the flip side, it has ₹282.5m in cash leading to net debt of about ₹189.8m.

How Healthy Is Veto Switchgears and Cables' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Veto Switchgears and Cables had liabilities of ₹776.1m due within 12 months and liabilities of ₹171.7m due beyond that. On the other hand, it had cash of ₹282.5m and ₹1.33b worth of receivables due within a year. So it can boast ₹669.3m more liquid assets than total liabilities.

This excess liquidity suggests that Veto Switchgears and Cables is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders.

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). 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 0.56 times EBITDA, Veto Switchgears and Cables is arguably pretty conservatively geared. And it boasts interest cover of 7.9 times, which is more than adequate. On the other hand, Veto Switchgears and Cables's EBIT dived 20%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Veto Switchgears and Cables will need earnings to service that debt. 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Veto Switchgears and Cables barely recorded positive free cash flow, in total. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Our View

Based on what we've seen Veto Switchgears and Cables is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to handle its debt, based on its EBITDA, is pretty flash. Looking at all this data makes us feel a little cautious about Veto Switchgears and Cables's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Veto Switchgears and Cables 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. 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.