Is Ruchi Infrastructure (NSE:RUCHINFRA) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Ruchi Infrastructure Limited (NSE:RUCHINFRA) makes use of debt. But is this debt a concern to shareholders?

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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Ruchi Infrastructure

How Much Debt Does Ruchi Infrastructure Carry?

You can click the graphic below for the historical numbers, but it shows that Ruchi Infrastructure had ₹1.51b of debt in September 2021, down from ₹1.62b, one year before. However, it also had ₹36.0m in cash, and so its net debt is ₹1.47b.

How Healthy Is Ruchi Infrastructure's Balance Sheet?

The latest balance sheet data shows that Ruchi Infrastructure had liabilities of ₹1.18b due within a year, and liabilities of ₹1.31b falling due after that. Offsetting these obligations, it had cash of ₹36.0m as well as receivables valued at ₹800.5m due within 12 months. So it has liabilities totalling ₹1.65b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of ₹2.07b, so it does suggest shareholders should keep an eye on Ruchi Infrastructure's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

Ruchi Infrastructure shareholders face the double whammy of a high net debt to EBITDA ratio (5.9), and fairly weak interest coverage, since EBIT is just 0.74 times the interest expense. The debt burden here is substantial. However, it should be some comfort for shareholders to recall that Ruchi Infrastructure actually grew its EBIT by a hefty 739%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. When analysing debt levels, the balance sheet is the obvious place to start. But it is Ruchi Infrastructure'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Ruchi Infrastructure actually produced more free cash flow than EBIT over the last two years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

We weren't impressed with Ruchi Infrastructure's net debt to EBITDA, and its interest cover made us cautious. But its conversion of EBIT to free cash flow was significantly redeeming. Looking at all this data makes us feel a little cautious about Ruchi Infrastructure's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. Be aware that Ruchi Infrastructure is showing 2 warning signs in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.