Is Aries Agro (NSE:ARIES) Using Too Much 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 Aries Agro Limited (NSE:ARIES) 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 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Aries Agro

How Much Debt Does Aries Agro Carry?

The image below, which you can click on for greater detail, shows that Aries Agro had debt of ₹1.10b at the end of September 2021, a reduction from ₹1.29b over a year. However, it also had ₹48.6m in cash, and so its net debt is ₹1.05b.

How Healthy Is Aries Agro's Balance Sheet?

The latest balance sheet data shows that Aries Agro had liabilities of ₹2.55b due within a year, and liabilities of ₹318.4m falling due after that. Offsetting this, it had ₹48.6m in cash and ₹1.32b in receivables that were due within 12 months. So its liabilities total ₹1.50b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of ₹1.56b. 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.

Even though Aries Agro's debt is only 2.0, its interest cover is really very low at 2.2. This does have us wondering if the company pays high interest because it is considered risky. In any case, it's safe to say the company has meaningful debt. We saw Aries Agro grow its EBIT by 4.4% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Aries Agro'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Aries Agro generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Aries Agro's interest cover and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Looking at all the angles mentioned above, it does seem to us that Aries Agro is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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 4 warning signs for Aries Agro you should be aware of, and 1 of them is a bit unpleasant.

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.