Is APL Apollo Tubes (NSE:APLAPOLLO) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that APL Apollo Tubes Limited (NSE:APLAPOLLO) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for APL Apollo Tubes

What Is APL Apollo Tubes's Net Debt?

You can click the graphic below for the historical numbers, but it shows that APL Apollo Tubes had ₹5.32b of debt in March 2021, down from ₹8.34b, one year before. However, it does have ₹3.61b in cash offsetting this, leading to net debt of about ₹1.71b.

How Healthy Is APL Apollo Tubes' Balance Sheet?

According to the last reported balance sheet, APL Apollo Tubes had liabilities of ₹11.8b due within 12 months, and liabilities of ₹3.88b due beyond 12 months. Offsetting these obligations, it had cash of ₹3.61b as well as receivables valued at ₹1.32b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹10.7b.

Of course, APL Apollo Tubes has a market capitalization of ₹165.5b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, APL Apollo Tubes has a very light debt load indeed.

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.

With net debt sitting at just 0.24 times EBITDA, APL Apollo Tubes is arguably pretty conservatively geared. And it boasts interest cover of 9.3 times, which is more than adequate. In addition to that, we're happy to report that APL Apollo Tubes has boosted its EBIT by 54%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine APL Apollo Tubes's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept 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 most recent three years, APL Apollo Tubes recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that APL Apollo Tubes's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Overall, we don't think APL Apollo Tubes is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for APL Apollo Tubes you should be aware of.

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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