Is Sarla Performance Fibers (NSE:SARLAPOLY) Using Too Much Debt?

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.' 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 can see that Sarla Performance Fibers Limited (NSE:SARLAPOLY) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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.

Check out our latest analysis for Sarla Performance Fibers

How Much Debt Does Sarla Performance Fibers Carry?

As you can see below, Sarla Performance Fibers had ₹1.18b of debt at March 2021, down from ₹2.68b a year prior. However, because it has a cash reserve of ₹1.15b, its net debt is less, at about ₹31.8m.

How Strong Is Sarla Performance Fibers' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sarla Performance Fibers had liabilities of ₹1.76b due within 12 months and liabilities of ₹645.2m due beyond that. On the other hand, it had cash of ₹1.15b and ₹944.7m worth of receivables due within a year. So its liabilities total ₹306.5m more than the combination of its cash and short-term receivables.

Since publicly traded Sarla Performance Fibers shares are worth a total of ₹3.97b, 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. Carrying virtually no net debt, Sarla Performance Fibers has a very light debt load indeed.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Sarla Performance Fibers's net debt to EBITDA ratio is very low, at 0.057, suggesting the debt is only trivial. Although with EBIT only covering interest expenses 2.7 times over, the company is truly paying for borrowing. Also relevant is that Sarla Performance Fibers has grown its EBIT by a very respectable 23% in the last year, thus enhancing its ability to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is Sarla Performance Fibers'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.

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 that EBIT is backed by free cash flow. Looking at the most recent three years, Sarla Performance Fibers recorded free cash flow of 29% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Sarla Performance Fibers's net debt to EBITDA suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its interest cover. Looking at all the aforementioned factors together, it strikes us that Sarla Performance Fibers can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. We've identified 3 warning signs with Sarla Performance Fibers (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. 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.
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