Dynemic Products (NSE:DYNPRO) Takes On Some Risk With Its Use Of Debt

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Dynemic Products Limited (NSE:DYNPRO) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Dynemic Products

What Is Dynemic Products's Debt?

As you can see below, at the end of September 2020, Dynemic Products had ₹1.04b of debt, up from ₹459.7m a year ago. Click the image for more detail. However, because it has a cash reserve of ₹112.2m, its net debt is less, at about ₹931.1m.

A Look At Dynemic Products's Liabilities

Zooming in on the latest balance sheet data, we can see that Dynemic Products had liabilities of ₹461.8m due within 12 months and liabilities of ₹840.8m due beyond that. On the other hand, it had cash of ₹112.2m and ₹380.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹809.6m.

While this might seem like a lot, it is not so bad since Dynemic Products has a market capitalization of ₹2.75b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). 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).

Dynemic Products's net debt to EBITDA ratio of about 2.3 suggests only moderate use of debt. And its strong interest cover of 31.5 times, makes us even more comfortable. If Dynemic Products can keep growing EBIT at last year's rate of 11% over the last year, then it will find its debt load easier to manage. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Dynemic Products will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Dynemic Products saw substantial negative free cash flow, in total. 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

Dynemic Products's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But its interest cover tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Dynemic Products is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 5 warning signs for Dynemic Products (2 are a bit unpleasant!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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