We Think Manaksia Coated Metals & Industries (NSE:MANAKCOAT) Is Taking Some Risk With Its Debt

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.' 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. As with many other companies Manaksia Coated Metals & Industries Limited (NSE:MANAKCOAT) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Manaksia Coated Metals & Industries

What Is Manaksia Coated Metals & Industries's Net Debt?

As you can see below, at the end of September 2021, Manaksia Coated Metals & Industries had ₹1.57b of debt, up from ₹1.42b a year ago. Click the image for more detail. However, it does have ₹172.1m in cash offsetting this, leading to net debt of about ₹1.40b.

A Look At Manaksia Coated Metals & Industries' Liabilities

Zooming in on the latest balance sheet data, we can see that Manaksia Coated Metals & Industries had liabilities of ₹2.49b due within 12 months and liabilities of ₹1.22b due beyond that. Offsetting this, it had ₹172.1m in cash and ₹827.8m in receivables that were due within 12 months. So its liabilities total ₹2.72b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₹1.50b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Manaksia Coated Metals & Industries would likely require a major re-capitalisation if it had to pay its creditors today.

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.

While Manaksia Coated Metals & Industries's debt to EBITDA ratio (3.9) suggests that it uses some debt, its interest cover is very weak, at 1.5, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Looking on the bright side, Manaksia Coated Metals & Industries boosted its EBIT by a silky 41% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing 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 Manaksia Coated Metals & Industries 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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Manaksia Coated Metals & Industries reported free cash flow worth 14% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, Manaksia Coated Metals & Industries's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Manaksia Coated Metals & Industries to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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. For example, we've discovered 3 warning signs for Manaksia Coated Metals & Industries (1 is potentially serious!) that you should be aware of before investing here.

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.