Here's Why Ashapura Minechem (NSE:ASHAPURMIN) Is Weighed Down By Its Debt Load

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Ashapura Minechem Limited (NSE:ASHAPURMIN) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. 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 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 Ashapura Minechem

How Much Debt Does Ashapura Minechem Carry?

The chart below, which you can click on for greater detail, shows that Ashapura Minechem had ₹6.02b in debt in September 2021; about the same as the year before. However, it also had ₹799.1m in cash, and so its net debt is ₹5.22b.

A Look At Ashapura Minechem's Liabilities

Zooming in on the latest balance sheet data, we can see that Ashapura Minechem had liabilities of ₹10.0b due within 12 months and liabilities of ₹7.53b due beyond that. Offsetting these obligations, it had cash of ₹799.1m as well as receivables valued at ₹3.91b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹12.8b.

Given this deficit is actually higher than the company's market capitalization of ₹10.1b, we think shareholders really should watch Ashapura Minechem's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Ashapura Minechem's net debt is sitting at a very reasonable 2.0 times its EBITDA, while its EBIT covered its interest expense just 4.2 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. We also note that Ashapura Minechem improved its EBIT from a last year's loss to a positive ₹2.1b. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Ashapura Minechem 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Ashapura Minechem burned a lot of cash. 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

Mulling over Ashapura Minechem's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. Having said that, its ability handle its debt, based on its EBITDA, isn't such a worry. We're quite clear that we consider Ashapura Minechem to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 6 warning signs for Ashapura Minechem (2 shouldn't be ignored) 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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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.