These 4 Measures Indicate That Airo Lam (NSE:AIROLAM) Is Using Debt Extensively

Warren Buffett famously said, '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 Airo Lam Limited (NSE:AIROLAM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Airo Lam

How Much Debt Does Airo Lam Carry?

As you can see below, Airo Lam had ₹508.1m of debt, at June 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have ₹25.1m in cash offsetting this, leading to net debt of about ₹483.0m.

How Healthy Is Airo Lam's Balance Sheet?

According to the last reported balance sheet, Airo Lam had liabilities of ₹804.2m due within 12 months, and liabilities of ₹182.6m due beyond 12 months. Offsetting this, it had ₹25.1m in cash and ₹548.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹412.8m.

While this might seem like a lot, it is not so bad since Airo Lam has a market capitalization of ₹1.88b, 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Airo Lam has a debt to EBITDA ratio of 2.6 and its EBIT covered its interest expense 3.2 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. On a slightly more positive note, Airo Lam grew its EBIT at 11% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Airo Lam will need earnings to service that debt. 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 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, Airo Lam saw substantial negative free cash flow, in total. 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

Airo Lam's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example, its EBIT growth rate is relatively strong. When we consider all the factors discussed, it seems to us that Airo Lam 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. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Airo Lam (of which 1 shouldn't be ignored!) you should know about.

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.