Is ShreeOswal Seeds and Chemicals (NSE:OSWALSEEDS) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that ShreeOswal Seeds and Chemicals Limited (NSE:OSWALSEEDS) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for ShreeOswal Seeds and Chemicals

What Is ShreeOswal Seeds and Chemicals's Net Debt?

As you can see below, ShreeOswal Seeds and Chemicals had ₹415.8m of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have ₹16.8m in cash offsetting this, leading to net debt of about ₹399.0m.

A Look At ShreeOswal Seeds and Chemicals' Liabilities

According to the last reported balance sheet, ShreeOswal Seeds and Chemicals had liabilities of ₹765.1m due within 12 months, and liabilities of ₹46.7m due beyond 12 months. Offsetting this, it had ₹16.8m in cash and ₹240.8m in receivables that were due within 12 months. So its liabilities total ₹554.3m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since ShreeOswal Seeds and Chemicals has a market capitalization of ₹1.35b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

ShreeOswal Seeds and Chemicals has a debt to EBITDA ratio of 3.8 and its EBIT covered its interest expense 3.9 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Looking on the bright side, ShreeOswal Seeds and Chemicals boosted its EBIT by a silky 37% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since ShreeOswal Seeds and Chemicals will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, ShreeOswal Seeds and Chemicals saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

ShreeOswal Seeds and Chemicals's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. Taking the abovementioned factors together we do think ShreeOswal Seeds and Chemicals's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for ShreeOswal Seeds and Chemicals (1 is significant) 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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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.