We Think Simbhaoli Sugars (NSE:SIMBHALS) Is Taking Some Risk With Its Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Simbhaoli Sugars Limited (NSE:SIMBHALS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Simbhaoli Sugars

How Much Debt Does Simbhaoli Sugars Carry?

As you can see below, Simbhaoli Sugars had ₹10.8b of debt at September 2021, down from ₹13.6b a year prior. However, because it has a cash reserve of ₹806.9m, its net debt is less, at about ₹10.0b.

A Look At Simbhaoli Sugars' Liabilities

According to the last reported balance sheet, Simbhaoli Sugars had liabilities of ₹17.7b due within 12 months, and liabilities of ₹812.9m due beyond 12 months. On the other hand, it had cash of ₹806.9m and ₹901.0m worth of receivables due within a year. So it has liabilities totalling ₹16.8b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the ₹939.1m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Simbhaoli Sugars would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Weak interest cover of 0.37 times and a disturbingly high net debt to EBITDA ratio of 25.1 hit our confidence in Simbhaoli Sugars like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Simbhaoli Sugars is that it turned last year's EBIT loss into a gain of ₹61m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Simbhaoli Sugars's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Simbhaoli Sugars actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On the face of it, Simbhaoli Sugars's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, it seems to us that Simbhaoli Sugars's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. To that end, you should be aware of the 1 warning sign we've spotted with Simbhaoli Sugars .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.