Incredible Industries (NSE:INCREDIBLE) Has A Somewhat Strained Balance Sheet

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.' 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. As with many other companies Incredible Industries Limited (NSE:INCREDIBLE) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Incredible Industries

How Much Debt Does Incredible Industries Carry?

The chart below, which you can click on for greater detail, shows that Incredible Industries had ₹403.9m in debt in March 2023; about the same as the year before. However, it does have ₹31.1m in cash offsetting this, leading to net debt of about ₹372.8m.

How Strong Is Incredible Industries' Balance Sheet?

The latest balance sheet data shows that Incredible Industries had liabilities of ₹600.8m due within a year, and liabilities of ₹225.5m falling due after that. On the other hand, it had cash of ₹31.1m and ₹272.6m worth of receivables due within a year. So it has liabilities totalling ₹522.5m more than its cash and near-term receivables, combined.

Incredible Industries has a market capitalization of ₹1.11b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). 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).

While Incredible Industries has a quite reasonable net debt to EBITDA multiple of 2.1, its interest cover seems weak, at 2.3. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. We saw Incredible Industries grow its EBIT by 8.8% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. There's no doubt that we learn most about debt from the balance sheet. But it is Incredible Industries'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 always check how much of that EBIT is translated into free cash flow. Over the last three years, Incredible Industries reported free cash flow worth 12% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Both Incredible Industries's interest cover and its conversion of EBIT to free cash flow were discouraging. But its not so bad at growing its EBIT. Taking the abovementioned factors together we do think Incredible Industries's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. Be aware that Incredible Industries is showing 2 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

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. 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.