K.C.P. Sugar and Industries (NSE:KCPSUGIND) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that K.C.P. Sugar and Industries Corporation Limited (NSE:KCPSUGIND) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 K.C.P. Sugar and Industries

How Much Debt Does K.C.P. Sugar and Industries Carry?

The chart below, which you can click on for greater detail, shows that K.C.P. Sugar and Industries had ₹1.85b in debt in March 2023; about the same as the year before. On the flip side, it has ₹1.18b in cash leading to net debt of about ₹664.4m.

How Healthy Is K.C.P. Sugar and Industries' Balance Sheet?

The latest balance sheet data shows that K.C.P. Sugar and Industries had liabilities of ₹1.96b due within a year, and liabilities of ₹600.2m falling due after that. On the other hand, it had cash of ₹1.18b and ₹255.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.12b.

This deficit isn't so bad because K.C.P. Sugar and Industries is worth ₹3.96b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

While we wouldn't worry about K.C.P. Sugar and Industries's net debt to EBITDA ratio of 4.3, we think its super-low interest cover of 0.71 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. The good news is that K.C.P. Sugar and Industries improved its EBIT by 3.6% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. There's no doubt that we learn most about debt from the balance sheet. But it is K.C.P. Sugar and Industries'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.

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. Happily for any shareholders, K.C.P. Sugar and Industries actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Based on what we've seen K.C.P. Sugar and Industries is not finding it easy, given its interest cover, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. Looking at all this data makes us feel a little cautious about K.C.P. Sugar and Industries's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for K.C.P. Sugar and Industries you should know about.

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. 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.