We Think W.S. Industries (India) (NSE:WSI) Is Taking Some Risk With Its 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 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. As with many other companies W.S. Industries (India) Limited (NSE:WSI) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. 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 W.S. Industries (India)

What Is W.S. Industries (India)'s Net Debt?

As you can see below, at the end of September 2023, W.S. Industries (India) had ₹582.5m of debt, up from ₹482.5m a year ago. Click the image for more detail. On the flip side, it has ₹80.0m in cash leading to net debt of about ₹502.5m.

A Look At W.S. Industries (India)'s Liabilities

The latest balance sheet data shows that W.S. Industries (India) had liabilities of ₹1.55b due within a year, and liabilities of ₹401.1m falling due after that. On the other hand, it had cash of ₹80.0m and ₹999.7m worth of receivables due within a year. So it has liabilities totalling ₹869.7m more than its cash and near-term receivables, combined.

Since publicly traded W.S. Industries (India) shares are worth a total of ₹6.20b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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 to EBITDA of 2.5 W.S. Industries (India) has a fairly noticeable amount of debt. On the plus side, its EBIT was 9.9 times its interest expense, and its net debt to EBITDA, was quite high, at 2.5. Notably, W.S. Industries (India) made a loss at the EBIT level, last year, but improved that to positive EBIT of ₹194m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is W.S. Industries (India)'s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, W.S. Industries (India) 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.

Our View

W.S. Industries (India)'s struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its interest cover was refreshing. We think that W.S. Industries (India)'s debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. 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 4 warning signs for W.S. Industries (India) (of which 2 shouldn't be ignored!) you should know about.

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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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.