These 4 Measures Indicate That Maharashtra Seamless (NSE:MAHSEAMLES) Is Using Debt Extensively

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Maharashtra Seamless Limited (NSE:MAHSEAMLES) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Maharashtra Seamless

How Much Debt Does Maharashtra Seamless Carry?

As you can see below, at the end of September 2020, Maharashtra Seamless had ₹10.6b of debt, up from ₹7.70b a year ago. Click the image for more detail. However, it also had ₹4.38b in cash, and so its net debt is ₹6.21b.

A Look At Maharashtra Seamless' Liabilities

Zooming in on the latest balance sheet data, we can see that Maharashtra Seamless had liabilities of ₹8.05b due within 12 months and liabilities of ₹10.3b due beyond that. Offsetting this, it had ₹4.38b in cash and ₹5.35b in receivables that were due within 12 months. So its liabilities total ₹8.67b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Maharashtra Seamless has a market capitalization of ₹18.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Maharashtra Seamless has a low net debt to EBITDA ratio of only 1.4. And its EBIT easily covers its interest expense, being 15.4 times the size. So we're pretty relaxed about its super-conservative use of debt. In fact Maharashtra Seamless's saving grace is its low debt levels, because its EBIT has tanked 46% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Maharashtra Seamless can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Maharashtra Seamless recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

To be frank both Maharashtra Seamless's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, we think it's fair to say that Maharashtra Seamless has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Maharashtra Seamless .

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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