Century Extrusions (NSE:CENTEXT) Has A Pretty Healthy Balance Sheet

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Century Extrusions Limited (NSE:CENTEXT) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 Century Extrusions

What Is Century Extrusions's Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Century Extrusions had debt of ₹457.7m, up from ₹429.1m in one year. On the flip side, it has ₹31.6m in cash leading to net debt of about ₹426.1m.

A Look At Century Extrusions' Liabilities

Zooming in on the latest balance sheet data, we can see that Century Extrusions had liabilities of ₹632.7m due within 12 months and liabilities of ₹143.1m due beyond that. Offsetting this, it had ₹31.6m in cash and ₹515.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹228.3m.

This deficit isn't so bad because Century Extrusions is worth ₹1.06b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

Century Extrusions's net debt is sitting at a very reasonable 2.2 times its EBITDA, while its EBIT covered its interest expense just 2.7 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. One way Century Extrusions could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 16%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is Century Extrusions'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Century Extrusions recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Based on what we've seen Century Extrusions is not finding it easy, given its interest cover, but the other factors we considered give us cause to be optimistic. There's no doubt that it has an adequate capacity to grow its EBIT. Looking at all this data makes us feel a little cautious about Century Extrusions's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Century Extrusions (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

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.