Is Mahamaya Steel Industries (NSE:MAHASTEEL) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Mahamaya Steel Industries Limited (NSE:MAHASTEEL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

View our latest analysis for Mahamaya Steel Industries

What Is Mahamaya Steel Industries's Debt?

As you can see below, Mahamaya Steel Industries had ₹422.9m of debt at September 2022, down from ₹598.9m a year prior. On the flip side, it has ₹203.7m in cash leading to net debt of about ₹219.2m.

How Strong Is Mahamaya Steel Industries' Balance Sheet?

We can see from the most recent balance sheet that Mahamaya Steel Industries had liabilities of ₹469.2m falling due within a year, and liabilities of ₹325.4m due beyond that. On the other hand, it had cash of ₹203.7m and ₹136.5m worth of receivables due within a year. So it has liabilities totalling ₹454.4m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Mahamaya Steel Industries has a market capitalization of ₹833.4m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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).

Mahamaya Steel Industries's net debt is sitting at a very reasonable 1.5 times its EBITDA, while its EBIT covered its interest expense just 3.7 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Shareholders should be aware that Mahamaya Steel Industries's EBIT was down 30% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Mahamaya Steel Industries will need earnings to service that debt. 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. Happily for any shareholders, Mahamaya Steel Industries actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Mahamaya Steel Industries's EBIT growth rate and interest cover definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Looking at all the angles mentioned above, it does seem to us that Mahamaya Steel Industries is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Mahamaya Steel Industries you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.