Is Century Extrusions (NSE:CENTEXT) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that Century Extrusions Limited (NSE:CENTEXT) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Century Extrusions

How Much Debt Does Century Extrusions Carry?

The image below, which you can click on for greater detail, shows that Century Extrusions had debt of ₹413.6m at the end of September 2023, a reduction from ₹479.9m over a year. However, it does have ₹61.8m in cash offsetting this, leading to net debt of about ₹351.8m.

How Strong Is Century Extrusions' Balance Sheet?

The latest balance sheet data shows that Century Extrusions had liabilities of ₹647.6m due within a year, and liabilities of ₹68.0m falling due after that. Offsetting these obligations, it had cash of ₹61.8m as well as receivables valued at ₹420.9m due within 12 months. So its liabilities total ₹232.9m more than the combination of its cash and short-term receivables.

Given Century Extrusions has a market capitalization of ₹1.55b, 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.

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.

Century Extrusions has net debt worth 1.6 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 2.7 times the interest expense. 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 saw Century Extrusions grow its EBIT by 9.9% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. 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, 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, Century Extrusions recorded free cash flow of 41% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Century Extrusions's interest cover was a real negative on this analysis, although the other factors we considered were considerably better. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Century Extrusions (of which 1 is concerning!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.