Auditors Have Doubts About Jindal Steel & Power (NSE:JINDALSTEL)

Unfortunately for shareholders, when Jindal Steel & Power Limited (NSE:JINDALSTEL) reported results for the period to June 2022, its auditors, Lodha & Co., expressed uncertainty about whether it can continue as a going concern. It is therefore fair to assume that, based on those financials, the company should strengthen its balance sheet in the short term, perhaps by issuing shares.

Given its situation, it may not be in a good position to raise capital on favorable terms. So it is suddenly extremely important to consider whether the company is taking too much risk on its balance sheet. The biggest concern we would have is the company's debt, since its lenders might force the company into administration if it cannot repay them.

View our latest analysis for Jindal Steel & Power

What Is Jindal Steel & Power's Debt?

You can click the graphic below for the historical numbers, but it shows that Jindal Steel & Power had ₹135.0b of debt in March 2022, down from ₹223.6b, one year before. However, it also had ₹40.0b in cash, and so its net debt is ₹95.0b.

How Healthy Is Jindal Steel & Power's Balance Sheet?

The latest balance sheet data shows that Jindal Steel & Power had liabilities of ₹227.0b due within a year, and liabilities of ₹168.5b falling due after that. On the other hand, it had cash of ₹40.0b and ₹15.1b worth of receivables due within a year. So it has liabilities totalling ₹340.3b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of ₹450.3b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

With net debt sitting at just 0.63 times EBITDA, Jindal Steel & Power is arguably pretty conservatively geared. And it boasts interest cover of 7.3 times, which is more than adequate. But the bad news is that Jindal Steel & Power has seen its EBIT plunge 14% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Jindal Steel & Power's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Jindal Steel & Power actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

On our analysis Jindal Steel & Power's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. In particular, EBIT growth rate gives us cold feet. When we consider all the factors mentioned above, we do feel a bit cautious about Jindal Steel & Power'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. Some investors may be interested in buying high risk stocks at the right price, but we prefer to avoid a company after its auditor has expressed any uncertainty about its ability to continue as a going concern. We prefer to invest in companies that ensure the balance sheet remains healthier than that. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Jindal Steel & Power (of which 1 is concerning!) 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. 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.