Does Aries Agro (NSE:ARIES) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Aries Agro Limited (NSE:ARIES) makes use of debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Aries Agro

What Is Aries Agro's Net Debt?

As you can see below, Aries Agro had ₹1.40b of debt at March 2021, down from ₹1.50b a year prior. However, because it has a cash reserve of ₹41.0m, its net debt is less, at about ₹1.36b.

A Look At Aries Agro's Liabilities

According to the last reported balance sheet, Aries Agro had liabilities of ₹2.59b due within 12 months, and liabilities of ₹238.6m due beyond 12 months. Offsetting this, it had ₹41.0m in cash and ₹1.23b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.56b.

This deficit is considerable relative to its market capitalization of ₹2.23b, so it does suggest shareholders should keep an eye on Aries Agro's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

While Aries Agro has a quite reasonable net debt to EBITDA multiple of 2.4, its interest cover seems weak, at 1.9. This does have us wondering if the company pays high interest because it is considered risky. Either way there's no doubt the stock is using meaningful leverage. It is well worth noting that Aries Agro's EBIT shot up like bamboo after rain, gaining 36% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Aries Agro's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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, Aries Agro recorded free cash flow worth a fulsome 93% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Both Aries Agro's ability to to convert EBIT to free cash flow and its EBIT growth rate gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to cover its interest expense with its EBIT. When we consider all the elements mentioned above, it seems to us that Aries Agro is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Aries Agro (of which 1 is potentially serious!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. 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.
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