These 4 Measures Indicate That Sarla Performance Fibers (NSE:SARLAPOLY) Is Using Debt Safely

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 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. As with many other companies Sarla Performance Fibers Limited (NSE:SARLAPOLY) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Sarla Performance Fibers

How Much Debt Does Sarla Performance Fibers Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Sarla Performance Fibers had debt of ₹1.51b, up from ₹1.20b in one year. However, it also had ₹590.0m in cash, and so its net debt is ₹921.8m.

How Strong Is Sarla Performance Fibers' Balance Sheet?

The latest balance sheet data shows that Sarla Performance Fibers had liabilities of ₹1.85b due within a year, and liabilities of ₹580.0m falling due after that. Offsetting these obligations, it had cash of ₹590.0m as well as receivables valued at ₹955.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹884.5m.

Since publicly traded Sarla Performance Fibers shares are worth a total of ₹6.80b, 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.

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

Sarla Performance Fibers has a low net debt to EBITDA ratio of only 1.1. And its EBIT covers its interest expense a whopping 15.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Even more impressive was the fact that Sarla Performance Fibers grew its EBIT by 129% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sarla Performance Fibers 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Sarla Performance Fibers recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Sarla Performance Fibers's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Considering this range of factors, it seems to us that Sarla Performance Fibers is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Sarla Performance Fibers , and understanding them should be part of your investment process.

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.