Here's Why Welspun Enterprises (NSE:WELENT) Is Weighed Down By Its Debt Load

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 Welspun Enterprises Limited (NSE:WELENT) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Welspun Enterprises

How Much Debt Does Welspun Enterprises Carry?

As you can see below, at the end of September 2020, Welspun Enterprises had ₹15.7b of debt, up from ₹8.12b a year ago. Click the image for more detail. On the flip side, it has ₹3.18b in cash leading to net debt of about ₹12.5b.

A Look At Welspun Enterprises' Liabilities

The latest balance sheet data shows that Welspun Enterprises had liabilities of ₹7.62b due within a year, and liabilities of ₹16.1b falling due after that. Offsetting these obligations, it had cash of ₹3.18b as well as receivables valued at ₹4.60b due within 12 months. So its liabilities total ₹15.9b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₹17.8b, so it does suggest shareholders should keep an eye on Welspun Enterprises' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a net debt to EBITDA ratio of 7.1, it's fair to say Welspun Enterprises does have a significant amount of debt. However, its interest coverage of 6.8 is reasonably strong, which is a good sign. Shareholders should be aware that Welspun Enterprises's EBIT was down 30% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Welspun Enterprises's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Welspun Enterprises burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Welspun Enterprises's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Taking into account all the aforementioned factors, it looks like Welspun Enterprises has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. For instance, we've identified 4 warning signs for Welspun Enterprises (1 shouldn't be ignored) you should be aware of.

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.

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