Indo Rama Synthetics (India) (NSE:INDORAMA) Use Of Debt Could Be Considered Risky

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Indo Rama Synthetics (India) Limited (NSE:INDORAMA) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Indo Rama Synthetics (India)

What Is Indo Rama Synthetics (India)'s Net Debt?

As you can see below, at the end of September 2024, Indo Rama Synthetics (India) had ₹12.3b of debt, up from ₹8.09b a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is Indo Rama Synthetics (India)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Indo Rama Synthetics (India) had liabilities of ₹20.4b due within 12 months and liabilities of ₹5.15b due beyond that. Offsetting this, it had ₹173.7m in cash and ₹1.82b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹23.6b.

This deficit casts a shadow over the ₹9.70b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Indo Rama Synthetics (India) would probably need a major re-capitalization if its creditors were to demand repayment.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.47 times and a disturbingly high net debt to EBITDA ratio of 11.2 hit our confidence in Indo Rama Synthetics (India) like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. One redeeming factor for Indo Rama Synthetics (India) is that it turned last year's EBIT loss into a gain of ₹660m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Indo Rama Synthetics (India)'s earnings that will influence how the balance sheet holds up in the future. 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 the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Indo Rama Synthetics (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

On the face of it, Indo Rama Synthetics (India)'s conversion of EBIT to free cash flow 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. Having said that, its ability to grow its EBIT isn't such a worry. We think the chances that Indo Rama Synthetics (India) has too much debt a very significant. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Indo Rama Synthetics (India) that you should be aware of.

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.