These 4 Measures Indicate That Magadh Sugar & Energy (NSE:MAGADSUGAR) Is Using Debt Reasonably Well

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. Importantly, Magadh Sugar & Energy Limited (NSE:MAGADSUGAR) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Magadh Sugar & Energy

What Is Magadh Sugar & Energy's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Magadh Sugar & Energy had debt of ₹3.74b, up from ₹2.13b in one year. And it doesn't have much cash, so its net debt is about the same.

A Look At Magadh Sugar & Energy's Liabilities

Zooming in on the latest balance sheet data, we can see that Magadh Sugar & Energy had liabilities of ₹2.85b due within 12 months and liabilities of ₹2.07b due beyond that. On the other hand, it had cash of ₹11.9m and ₹348.4m worth of receivables due within a year. So it has liabilities totalling ₹4.56b more than its cash and near-term receivables, combined.

Magadh Sugar & Energy has a market capitalization of ₹7.72b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Magadh Sugar & Energy has net debt worth 1.9 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 4.9 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Magadh Sugar & Energy grew its EBIT by 7.9% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. There's no doubt that we learn most about debt from the balance sheet. But it is Magadh Sugar & Energy'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Magadh Sugar & Energy produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Magadh Sugar & Energy's conversion of EBIT to free cash flow was a real positive on this analysis, as was its EBIT growth rate. On the other hand, its level of total liabilities makes us a little less comfortable about its debt. Looking at all this data makes us feel a little cautious about Magadh Sugar & Energy'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. 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. We've identified 4 warning signs with Magadh Sugar & Energy (at least 2 which shouldn't be ignored) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.