Jayant Agro-Organics (NSE:JAYAGROGN) Seems To Use Debt Quite Sensibly

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. We can see that Jayant Agro-Organics Limited (NSE:JAYAGROGN) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Jayant Agro-Organics

What Is Jayant Agro-Organics's Net Debt?

As you can see below, Jayant Agro-Organics had ₹1.51b of debt at March 2021, down from ₹1.79b a year prior. However, it does have ₹82.5m in cash offsetting this, leading to net debt of about ₹1.43b.

How Strong Is Jayant Agro-Organics' Balance Sheet?

We can see from the most recent balance sheet that Jayant Agro-Organics had liabilities of ₹2.30b falling due within a year, and liabilities of ₹379.5m due beyond that. On the other hand, it had cash of ₹82.5m and ₹1.59b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.00b.

Of course, Jayant Agro-Organics has a market capitalization of ₹5.76b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

Looking at its net debt to EBITDA of 1.5 and interest cover of 5.8 times, it seems to us that Jayant Agro-Organics is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Although Jayant Agro-Organics made a loss at the EBIT level, last year, it was also good to see that it generated ₹836m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Jayant Agro-Organics's earnings that will influence how the balance sheet holds up in the future. 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 the earnings before interest and tax (EBIT) is backed by free cash flow. In the last year, Jayant Agro-Organics's free cash flow amounted to 40% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Jayant Agro-Organics's net debt to EBITDA was a real positive on this analysis, as was its level of total liabilities. Having said that, its conversion of EBIT to free cash flow somewhat sensitizes us to potential future risks to the balance sheet. When we consider all the factors mentioned above, we do feel a bit cautious about Jayant Agro-Organics's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Jayant Agro-Organics has 4 warning signs (and 1 which can't be ignored) we think 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.

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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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