Is Kamdhenu (NSE:KAMDHENU) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Kamdhenu Limited (NSE:KAMDHENU) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kamdhenu

How Much Debt Does Kamdhenu Carry?

You can click the graphic below for the historical numbers, but it shows that Kamdhenu had ₹882.9m of debt in September 2021, down from ₹1.07b, one year before. However, it also had ₹131.0m in cash, and so its net debt is ₹751.9m.

How Strong Is Kamdhenu's Balance Sheet?

The latest balance sheet data shows that Kamdhenu had liabilities of ₹1.99b due within a year, and liabilities of ₹373.4m falling due after that. Offsetting these obligations, it had cash of ₹131.0m as well as receivables valued at ₹2.10b due within 12 months. So it has liabilities totalling ₹137.5m more than its cash and near-term receivables, combined.

Of course, Kamdhenu has a market capitalization of ₹5.64b, 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Looking at its net debt to EBITDA of 1.3 and interest cover of 4.8 times, it seems to us that Kamdhenu 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. It is well worth noting that Kamdhenu's EBIT shot up like bamboo after rain, gaining 72% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Kamdhenu 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Kamdhenu recorded free cash flow of 37% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Kamdhenu's EBIT growth rate 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 conversion of EBIT to free cash flow does undermine this impression a bit. When we consider the range of factors above, it looks like Kamdhenu is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. For example, we've discovered 2 warning signs for Kamdhenu that you should be aware of before investing here.

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.