Here's Why Hisar Metal Industries (NSE:HISARMETAL) Is Weighed Down By Its Debt Load

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Hisar Metal Industries Limited (NSE:HISARMETAL) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 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 Hisar Metal Industries

What Is Hisar Metal Industries's Debt?

The chart below, which you can click on for greater detail, shows that Hisar Metal Industries had ₹535.2m in debt in September 2020; about the same as the year before. However, it does have ₹31.8m in cash offsetting this, leading to net debt of about ₹503.4m.

How Healthy Is Hisar Metal Industries's Balance Sheet?

The latest balance sheet data shows that Hisar Metal Industries had liabilities of ₹477.0m due within a year, and liabilities of ₹236.6m falling due after that. Offsetting this, it had ₹31.8m in cash and ₹270.6m in receivables that were due within 12 months. So it has liabilities totalling ₹411.2m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of ₹460.4m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.6 times and a disturbingly high net debt to EBITDA ratio of 5.4 hit our confidence in Hisar Metal Industries like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Hisar Metal Industries saw its EBIT tank 45% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hisar Metal Industries 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.

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. Over the last three years, Hisar Metal Industries reported free cash flow worth 9.9% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, Hisar Metal Industries's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its conversion of EBIT to free cash flow also fails to instill confidence. After considering the datapoints discussed, we think Hisar Metal Industries has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for Hisar Metal Industries (of which 2 shouldn't be ignored!) you should know about.

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. 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.
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