Is Indian Metals and Ferro Alloys (NSE:IMFA) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Indian Metals and Ferro Alloys Limited (NSE:IMFA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Indian Metals and Ferro Alloys

What Is Indian Metals and Ferro Alloys's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Indian Metals and Ferro Alloys had ₹5.74b of debt in March 2021, down from ₹6.97b, one year before. However, because it has a cash reserve of ₹1.72b, its net debt is less, at about ₹4.02b.

How Healthy Is Indian Metals and Ferro Alloys' Balance Sheet?

We can see from the most recent balance sheet that Indian Metals and Ferro Alloys had liabilities of ₹7.41b falling due within a year, and liabilities of ₹5.28b due beyond that. On the other hand, it had cash of ₹1.72b and ₹922.0m worth of receivables due within a year. So its liabilities total ₹10.0b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of ₹13.3b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Indian Metals and Ferro Alloys's low debt to EBITDA ratio of 1.2 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.7 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Notably, Indian Metals and Ferro Alloys's EBIT launched higher than Elon Musk, gaining a whopping 1,322% on last year. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Indian Metals and Ferro Alloys 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 always check how much of that EBIT is translated into free cash flow. During the last three years, Indian Metals and Ferro Alloys generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Indian Metals and Ferro Alloys's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its interest cover does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Indian Metals and Ferro Alloys can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Indian Metals and Ferro Alloys has 2 warning signs we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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