Aarti Industries (NSE:AARTIIND) Has A Somewhat Strained Balance Sheet

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Aarti Industries Limited (NSE:AARTIIND) makes use of debt. But should shareholders be worried about its use of debt?

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Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

What Is Aarti Industries's Net Debt?

As you can see below, at the end of March 2025, Aarti Industries had ₹37.9b of debt, up from ₹31.8b a year ago. Click the image for more detail. However, it does have ₹1.99b in cash offsetting this, leading to net debt of about ₹35.9b.

How Healthy Is Aarti Industries' Balance Sheet?

According to the last reported balance sheet, Aarti Industries had liabilities of ₹34.7b due within 12 months, and liabilities of ₹20.4b due beyond 12 months. On the other hand, it had cash of ₹1.99b and ₹7.92b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹45.2b.

While this might seem like a lot, it is not so bad since Aarti Industries has a market capitalization of ₹173.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

View our latest analysis for Aarti Industries

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about Aarti Industries's net debt to EBITDA ratio of 3.6, we think its super-low interest cover of 2.1 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. More concerning, Aarti Industries saw its EBIT drop by 5.3% in the last twelve months. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Aarti Industries can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last three years, Aarti Industries recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On the face of it, Aarti Industries's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least its level of total liabilities is not so bad. Looking at the bigger picture, it seems clear to us that Aarti Industries's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Aarti Industries has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.