Is M M Forgings (NSE:MMFL) A Risky Investment?

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. We note that M M Forgings Limited (NSE:MMFL) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for M M Forgings

What Is M M Forgings's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 M M Forgings had debt of ₹5.90b, up from ₹5.16b in one year. However, it does have ₹2.18b in cash offsetting this, leading to net debt of about ₹3.73b.

How Strong Is M M Forgings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that M M Forgings had liabilities of ₹3.50b due within 12 months and liabilities of ₹3.80b due beyond that. Offsetting this, it had ₹2.18b in cash and ₹1.40b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹3.72b.

Of course, M M Forgings has a market capitalization of ₹21.6b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a debt to EBITDA ratio of 1.8, M M Forgings uses debt artfully but responsibly. And the alluring interest cover (EBIT of 9.8 times interest expense) certainly does not do anything to dispel this impression. Notably, M M Forgings's EBIT launched higher than Elon Musk, gaining a whopping 293% on last year. 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 M M Forgings 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. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, M M Forgings recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, M M Forgings's impressive EBIT growth rate implies it has the upper hand on its debt. And that's just the beginning of the good news since its interest cover is also very heartening. When we consider the range of factors above, it looks like M M Forgings is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example M M Forgings has 3 warning signs (and 2 which are a bit concerning) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.