AGI Greenpac (NSE:AGI) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that AGI Greenpac Limited (NSE:AGI) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for AGI Greenpac

What Is AGI Greenpac's Debt?

As you can see below, AGI Greenpac had ₹10.6b of debt, at September 2022, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has ₹2.30b in cash leading to net debt of about ₹8.27b.

How Strong Is AGI Greenpac's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that AGI Greenpac had liabilities of ₹9.43b due within 12 months and liabilities of ₹8.34b due beyond that. Offsetting these obligations, it had cash of ₹2.30b as well as receivables valued at ₹4.45b due within 12 months. So it has liabilities totalling ₹11.0b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since AGI Greenpac has a market capitalization of ₹23.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

AGI Greenpac has net debt worth 2.2 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 6.8 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. If AGI Greenpac can keep growing EBIT at last year's rate of 18% over the last year, then it will find its debt load easier to manage. The balance sheet is clearly the area to focus on when you are analysing debt. But it is AGI Greenpac'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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, AGI Greenpac burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

AGI Greenpac's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its EBIT growth rate was refreshing. When we consider all the factors discussed, it seems to us that AGI Greenpac is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for AGI Greenpac you should be aware of, and 1 of them is potentially serious.

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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