Stock Analysis

Does Dwarikesh Sugar Industries (NSE:DWARKESH) Have A Healthy Balance Sheet?

NSEI:DWARKESH
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Warren Buffett famously said, '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. We note that Dwarikesh Sugar Industries Limited (NSE:DWARKESH) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Dwarikesh Sugar Industries

What Is Dwarikesh Sugar Industries's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Dwarikesh Sugar Industries had debt of ₹5.59b, up from ₹3.99b in one year. Net debt is about the same, since the it doesn't have much cash.

debt-equity-history-analysis
NSEI:DWARKESH Debt to Equity History February 24th 2021

How Strong Is Dwarikesh Sugar Industries' Balance Sheet?

The latest balance sheet data shows that Dwarikesh Sugar Industries had liabilities of ₹5.33b due within a year, and liabilities of ₹1.94b falling due after that. Offsetting these obligations, it had cash of ₹16.3m as well as receivables valued at ₹528.7m due within 12 months. So it has liabilities totalling ₹6.73b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of ₹5.05b, we think shareholders really should watch Dwarikesh Sugar Industries's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Dwarikesh Sugar Industries has a debt to EBITDA ratio of 3.3 and its EBIT covered its interest expense 3.0 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Fortunately, Dwarikesh Sugar Industries grew its EBIT by 7.5% in the last year, slowly shrinking its debt relative to earnings. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Dwarikesh Sugar Industries 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Dwarikesh Sugar Industries burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Dwarikesh Sugar Industries's level of total liabilities and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. We're quite clear that we consider Dwarikesh Sugar Industries to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Be aware that Dwarikesh Sugar Industries is showing 3 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

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. 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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