These 4 Measures Indicate That Mishra Dhatu Nigam (NSE:MIDHANI) Is Using Debt Extensively

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Mishra Dhatu Nigam Limited (NSE:MIDHANI) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Mishra Dhatu Nigam

What Is Mishra Dhatu Nigam's Net Debt?

As you can see below, at the end of September 2020, Mishra Dhatu Nigam had ₹1.50b of debt, up from ₹605.0m a year ago. Click the image for more detail. However, it also had ₹417.0m in cash, and so its net debt is ₹1.09b.

How Healthy Is Mishra Dhatu Nigam's Balance Sheet?

We can see from the most recent balance sheet that Mishra Dhatu Nigam had liabilities of ₹6.83b falling due within a year, and liabilities of ₹7.48b due beyond that. On the other hand, it had cash of ₹417.0m and ₹3.37b worth of receivables due within a year. So it has liabilities totalling ₹10.5b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Mishra Dhatu Nigam has a market capitalization of ₹35.2b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Mishra Dhatu Nigam has a low debt to EBITDA ratio of only 0.66. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So there's no doubt this company can take on debt while staying cool as a cucumber. It is just as well that Mishra Dhatu Nigam's load is not too heavy, because its EBIT was down 30% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is Mishra Dhatu Nigam's earnings that will influence how the balance sheet holds up in the future. 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Mishra Dhatu Nigam burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Mishra Dhatu Nigam's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Mishra Dhatu Nigam stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Mishra Dhatu Nigam (1 is concerning!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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