Is Manaksia Steels (NSE:MANAKSTEEL) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Manaksia Steels Limited (NSE:MANAKSTEEL) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Manaksia Steels

What Is Manaksia Steels's Debt?

As you can see below, at the end of September 2020, Manaksia Steels had ₹287.6m of debt, up from ₹162.8m a year ago. Click the image for more detail. But it also has ₹349.3m in cash to offset that, meaning it has ₹61.7m net cash.

How Strong Is Manaksia Steels' Balance Sheet?

According to the last reported balance sheet, Manaksia Steels had liabilities of ₹1.12b due within 12 months, and liabilities of ₹41.2m due beyond 12 months. On the other hand, it had cash of ₹349.3m and ₹306.5m worth of receivables due within a year. So it has liabilities totalling ₹505.7m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Manaksia Steels has a market capitalization of ₹1.38b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Manaksia Steels also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Manaksia Steels grew its EBIT by 172% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Steels 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Manaksia Steels has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Manaksia Steels actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While Manaksia Steels does have more liabilities than liquid assets, it also has net cash of ₹61.7m. The cherry on top was that in converted 167% of that EBIT to free cash flow, bringing in ₹163m. So we don't think Manaksia Steels's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Manaksia Steels .

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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