Here's Why SKM Egg Products Export (India) (NSE:SKMEGGPROD) Has A Meaningful Debt Burden

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies SKM Egg Products Export (India) Limited (NSE:SKMEGGPROD) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 SKM Egg Products Export (India)

What Is SKM Egg Products Export (India)'s Debt?

As you can see below, at the end of September 2021, SKM Egg Products Export (India) had ₹700.7m of debt, up from ₹557.5m a year ago. Click the image for more detail. However, it also had ₹323.1m in cash, and so its net debt is ₹377.6m.

A Look At SKM Egg Products Export (India)'s Liabilities

Zooming in on the latest balance sheet data, we can see that SKM Egg Products Export (India) had liabilities of ₹828.2m due within 12 months and liabilities of ₹160.5m due beyond that. On the other hand, it had cash of ₹323.1m and ₹200.5m worth of receivables due within a year. So it has liabilities totalling ₹465.1m more than its cash and near-term receivables, combined.

SKM Egg Products Export (India) has a market capitalization of ₹1.66b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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).

SKM Egg Products Export (India)'s net debt is sitting at a very reasonable 2.0 times its EBITDA, while its EBIT covered its interest expense just 5.4 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly, SKM Egg Products Export (India)'s EBIT fell a jaw-dropping 36% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is SKM Egg Products Export (India)'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, SKM Egg Products Export (India) created free cash flow amounting to 12% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Mulling over SKM Egg Products Export (India)'s attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least its interest cover is not so bad. Once we consider all the factors above, together, it seems to us that SKM Egg Products Export (India)'s debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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 3 warning signs we've spotted with SKM Egg Products Export (India) .

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.

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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.