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

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, APL Apollo Tubes Limited (NSE:APLAPOLLO) does carry debt. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for APL Apollo Tubes

What Is APL Apollo Tubes's Net Debt?

As you can see below, at the end of September 2022, APL Apollo Tubes had ₹9.52b of debt, up from ₹5.51b a year ago. Click the image for more detail. However, because it has a cash reserve of ₹6.62b, its net debt is less, at about ₹2.90b.

How Healthy Is APL Apollo Tubes' Balance Sheet?

According to the last reported balance sheet, APL Apollo Tubes had liabilities of ₹16.7b due within 12 months, and liabilities of ₹6.67b due beyond 12 months. Offsetting these obligations, it had cash of ₹6.62b as well as receivables valued at ₹1.07b due within 12 months. So it has liabilities totalling ₹15.7b more than its cash and near-term receivables, combined.

Given APL Apollo Tubes has a market capitalization of ₹301.8b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. But either way, APL Apollo Tubes has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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.

APL Apollo Tubes's net debt is only 0.32 times its EBITDA. And its EBIT easily covers its interest expense, being 37.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that APL Apollo Tubes saw its EBIT decline by 3.3% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 APL Apollo Tubes 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, APL Apollo Tubes recorded free cash flow of 43% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, APL Apollo Tubes's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its EBIT growth rate. Looking at all the aforementioned factors together, it strikes us that APL Apollo Tubes can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. We've identified 1 warning sign with APL Apollo Tubes , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.