Mawana Sugars (NSE:MAWANASUG) Use Of Debt Could Be Considered Risky

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.' 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 note that Mawana Sugars Limited (NSE:MAWANASUG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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

Check out our latest analysis for Mawana Sugars

What Is Mawana Sugars's Debt?

The image below, which you can click on for greater detail, shows that Mawana Sugars had debt of ₹3.83b at the end of March 2023, a reduction from ₹4.17b over a year. However, it also had ₹268.3m in cash, and so its net debt is ₹3.56b.

A Look At Mawana Sugars' Liabilities

We can see from the most recent balance sheet that Mawana Sugars had liabilities of ₹6.31b falling due within a year, and liabilities of ₹178.2m due beyond that. Offsetting this, it had ₹268.3m in cash and ₹419.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹5.80b.

Given this deficit is actually higher than the company's market capitalization of ₹4.28b, we think shareholders really should watch Mawana Sugars's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

Mawana Sugars shareholders face the double whammy of a high net debt to EBITDA ratio (5.1), and fairly weak interest coverage, since EBIT is just 1.3 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, Mawana Sugars saw its EBIT tank 36% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But it is Mawana Sugars'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Mawana Sugars recorded free cash flow worth 55% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

On the face of it, Mawana Sugars's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Taking into account all the aforementioned factors, it looks like Mawana Sugars has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. Be aware that Mawana Sugars is showing 4 warning signs in our investment analysis , and 1 of those is concerning...

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.