Is Ponni Sugars (Erode) (NSE:PONNIERODE) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Ponni Sugars (Erode) Limited (NSE:PONNIERODE) does use debt in its business. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Ponni Sugars (Erode)

What Is Ponni Sugars (Erode)'s Debt?

You can click the graphic below for the historical numbers, but it shows that Ponni Sugars (Erode) had ₹201.3m of debt in March 2020, down from ₹348.7m, one year before. However, because it has a cash reserve of ₹4.40m, its net debt is less, at about ₹196.9m.

How Healthy Is Ponni Sugars (Erode)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ponni Sugars (Erode) had liabilities of ₹560.5m due within 12 months and liabilities of ₹117.5m due beyond that. Offsetting this, it had ₹4.40m in cash and ₹696.0m in receivables that were due within 12 months. So it can boast ₹22.4m more liquid assets than total liabilities.

Having regard to Ponni Sugars (Erode)'s size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹1.29b company is short on cash, but still worth keeping an eye on the balance sheet.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Ponni Sugars (Erode) has net debt of just 0.48 times EBITDA, suggesting it could ramp leverage without breaking a sweat. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. Even more impressive was the fact that Ponni Sugars (Erode) grew its EBIT by 148% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ponni Sugars (Erode)'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. Over the most recent three years, Ponni Sugars (Erode) recorded free cash flow worth 52% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Ponni Sugars (Erode)'s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Overall, we don't think Ponni Sugars (Erode) is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Ponni Sugars (Erode) .

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.

If you’re looking to trade Ponni Sugars (Erode), open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.