Is RITES (NSE:RITES) A Risky Investment?

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.' 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. We note that RITES Limited (NSE:RITES) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for RITES

What Is RITES's Debt?

As you can see below, RITES had ₹275.9m of debt at March 2022, down from ₹288.8m a year prior. But it also has ₹7.84b in cash to offset that, meaning it has ₹7.56b net cash.

How Healthy Is RITES' Balance Sheet?

The latest balance sheet data shows that RITES had liabilities of ₹30.1b due within a year, and liabilities of ₹2.15b falling due after that. Offsetting these obligations, it had cash of ₹7.84b as well as receivables valued at ₹9.92b due within 12 months. So its liabilities total ₹14.5b more than the combination of its cash and short-term receivables.

Since publicly traded RITES shares are worth a total of ₹77.8b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, RITES boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that RITES has boosted its EBIT by 51%, thus reducing the spectre of future debt repayments. 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 RITES 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. RITES may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, RITES's free cash flow amounted to 37% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

Although RITES's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₹7.56b. And it impressed us with its EBIT growth of 51% over the last year. So is RITES's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with RITES .

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.