These 4 Measures Indicate That Walchandnagar Industries (NSE:WALCHANNAG) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Walchandnagar Industries Limited (NSE:WALCHANNAG) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Walchandnagar Industries

What Is Walchandnagar Industries's Net Debt?

As you can see below, at the end of September 2020, Walchandnagar Industries had ₹4.04b of debt, up from ₹3.83b a year ago. Click the image for more detail. However, it does have ₹480.5m in cash offsetting this, leading to net debt of about ₹3.56b.

How Healthy Is Walchandnagar Industries' Balance Sheet?

We can see from the most recent balance sheet that Walchandnagar Industries had liabilities of ₹4.78b falling due within a year, and liabilities of ₹3.11b due beyond that. Offsetting this, it had ₹480.5m in cash and ₹2.70b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹4.70b.

This deficit casts a shadow over the ₹2.63b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Walchandnagar Industries would likely require a major re-capitalisation if it had to pay its creditors today.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Walchandnagar Industries shareholders face the double whammy of a high net debt to EBITDA ratio (15.8), and fairly weak interest coverage, since EBIT is just 0.0038 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, Walchandnagar Industries saw its EBIT tank 100% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. 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 Walchandnagar Industries will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Walchandnagar Industries actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, Walchandnagar Industries's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Taking into account all the aforementioned factors, it looks like Walchandnagar Industries has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Walchandnagar Industries , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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