Does Nahar Spinning Mills (NSE:NAHARSPING) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Nahar Spinning Mills Limited (NSE:NAHARSPING) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Nahar Spinning Mills

What Is Nahar Spinning Mills's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Nahar Spinning Mills had debt of ₹8.11b, up from ₹6.94b in one year. And it doesn't have much cash, so its net debt is about the same.

A Look At Nahar Spinning Mills' Liabilities

We can see from the most recent balance sheet that Nahar Spinning Mills had liabilities of ₹8.57b falling due within a year, and liabilities of ₹1.62b due beyond that. Offsetting this, it had ₹73.4m in cash and ₹4.76b in receivables that were due within 12 months. So it has liabilities totalling ₹5.35b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Nahar Spinning Mills has a market capitalization of ₹19.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). 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 sitting at just 1.4 times EBITDA, Nahar Spinning Mills is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 8.2 times the interest expense over the last year. Although Nahar Spinning Mills made a loss at the EBIT level, last year, it was also good to see that it generated ₹4.9b in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Nahar Spinning Mills'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, Nahar Spinning Mills recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Nahar Spinning Mills's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. But on the bright side, its ability to to cover its interest expense with its EBIT isn't too shabby at all. Taking the abovementioned factors together we do think Nahar Spinning Mills's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Case in point: We've spotted 4 warning signs for Nahar Spinning Mills you should be aware of, and 2 of them are a bit unpleasant.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.