Is Avadh Sugar & Energy (NSE:AVADHSUGAR) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Avadh Sugar & Energy Limited (NSE:AVADHSUGAR) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 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 Avadh Sugar & Energy

What Is Avadh Sugar & Energy's Debt?

You can click the graphic below for the historical numbers, but it shows that Avadh Sugar & Energy had ₹15.3b of debt in September 2020, down from ₹17.8b, one year before. And it doesn't have much cash, so its net debt is about the same.

A Look At Avadh Sugar & Energy's Liabilities

According to the last reported balance sheet, Avadh Sugar & Energy had liabilities of ₹11.3b due within 12 months, and liabilities of ₹5.97b due beyond 12 months. Offsetting these obligations, it had cash of ₹48.0m as well as receivables valued at ₹860.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹16.4b.

This deficit casts a shadow over the ₹3.88b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Avadh Sugar & Energy would probably need a major re-capitalization if its creditors were to demand repayment.

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

Avadh Sugar & Energy shareholders face the double whammy of a high net debt to EBITDA ratio (6.2), and fairly weak interest coverage, since EBIT is just 1.8 times the interest expense. The debt burden here is substantial. Worse, Avadh Sugar & Energy's EBIT was down 25% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Avadh Sugar & Energy 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 three years, Avadh Sugar & Energy 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

On the face of it, Avadh Sugar & Energy's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its interest cover fails to inspire much confidence. Considering everything we've mentioned above, it's fair to say that Avadh Sugar & Energy is carrying heavy debt load. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. 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. For instance, we've identified 5 warning signs for Avadh Sugar & Energy (2 don't sit too well with us) you should be aware of.

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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