We Think N R Agarwal Industries (NSE:NRAIL) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that N R Agarwal Industries Limited (NSE:NRAIL) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for N R Agarwal Industries

How Much Debt Does N R Agarwal Industries Carry?

The image below, which you can click on for greater detail, shows that N R Agarwal Industries had debt of ₹965.6m at the end of September 2022, a reduction from ₹1.96b over a year. However, it does have ₹303.7m in cash offsetting this, leading to net debt of about ₹662.0m.

How Strong Is N R Agarwal Industries' Balance Sheet?

The latest balance sheet data shows that N R Agarwal Industries had liabilities of ₹2.12b due within a year, and liabilities of ₹1.76b falling due after that. On the other hand, it had cash of ₹303.7m and ₹1.97b worth of receivables due within a year. So its liabilities total ₹1.61b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since N R Agarwal Industries has a market capitalization of ₹4.70b, 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.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

N R Agarwal Industries's net debt is only 0.36 times its EBITDA. And its EBIT covers its interest expense a whopping 11.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, N R Agarwal Industries grew its EBIT by 57% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is N R Agarwal Industries's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, N R Agarwal Industries recorded free cash flow of 50% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

N R Agarwal Industries's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its interest cover is also very heartening. Taking all this data into account, it seems to us that N R Agarwal Industries takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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 instance, we've identified 2 warning signs for N R Agarwal Industries (1 is significant) you should be aware of.

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.