Nahar Spinning Mills (NSE:NAHARSPING) Has A Pretty Healthy Balance Sheet

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 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 the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Nahar Spinning Mills

What Is Nahar Spinning Mills's Debt?

As you can see below, Nahar Spinning Mills had ₹10.1b of debt at March 2022, down from ₹10.7b a year prior. And it doesn't have much cash, so its net debt is about the same.

How Strong Is Nahar Spinning Mills' Balance Sheet?

According to the last reported balance sheet, Nahar Spinning Mills had liabilities of ₹11.4b due within 12 months, and liabilities of ₹2.14b due beyond 12 months. Offsetting these obligations, it had cash of ₹37.5m as well as receivables valued at ₹5.31b due within 12 months. So it has liabilities totalling ₹8.16b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of ₹12.2b, so it does suggest shareholders should keep an eye on Nahar Spinning Mills' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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).

Nahar Spinning Mills's net debt is only 1.3 times its EBITDA. And its EBIT easily covers its interest expense, being 10.7 times the size. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Nahar Spinning Mills grew its EBIT by 540% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Nahar Spinning Mills will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last two years, Nahar Spinning Mills recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Nahar Spinning Mills's EBIT growth rate was a real positive on this analysis, as was its interest cover. But truth be told its conversion of EBIT to free cash flow had us nibbling our nails. Looking at all this data makes us feel a little cautious about Nahar Spinning Mills's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Case in point: We've spotted 3 warning signs for Nahar Spinning Mills you should be aware of.

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.

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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.