These 4 Measures Indicate That Rajshree Sugars and Chemicals (NSE:RAJSREESUG) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Rajshree Sugars and Chemicals Limited (NSE:RAJSREESUG) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Rajshree Sugars and Chemicals

What Is Rajshree Sugars and Chemicals's Net Debt?

The image below, which you can click on for greater detail, shows that Rajshree Sugars and Chemicals had debt of ₹4.01b at the end of March 2023, a reduction from ₹4.27b over a year. Net debt is about the same, since the it doesn't have much cash.

How Strong Is Rajshree Sugars and Chemicals' Balance Sheet?

We can see from the most recent balance sheet that Rajshree Sugars and Chemicals had liabilities of ₹1.86b falling due within a year, and liabilities of ₹3.81b due beyond that. Offsetting this, it had ₹19.0m in cash and ₹435.4m in receivables that were due within 12 months. So it has liabilities totalling ₹5.22b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₹1.81b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Rajshree Sugars and Chemicals would probably need a major re-capitalization if its creditors were to demand repayment.

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). 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).

Rajshree Sugars and Chemicals has a rather high debt to EBITDA ratio of 5.6 which suggests a meaningful debt load. However, its interest coverage of 3.4 is reasonably strong, which is a good sign. However, it should be some comfort for shareholders to recall that Rajshree Sugars and Chemicals actually grew its EBIT by a hefty 323%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Rajshree Sugars and Chemicals will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Rajshree Sugars and Chemicals recorded free cash flow worth a fulsome 92% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

While Rajshree Sugars and Chemicals's level of total liabilities has us nervous. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. Taking the abovementioned factors together we do think Rajshree Sugars 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. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Rajshree Sugars and Chemicals (of which 1 shouldn't be ignored!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.