Does Premier Explosives (NSE:PREMEXPLN) Have A Healthy Balance Sheet?

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.' 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, Premier Explosives Limited (NSE:PREMEXPLN) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Premier Explosives

How Much Debt Does Premier Explosives Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Premier Explosives had ₹913.3m of debt, an increase on ₹561.4m, over one year. However, it does have ₹116.8m in cash offsetting this, leading to net debt of about ₹796.5m.

A Look At Premier Explosives' Liabilities

Zooming in on the latest balance sheet data, we can see that Premier Explosives had liabilities of ₹2.39b due within 12 months and liabilities of ₹377.6m due beyond that. Offsetting these obligations, it had cash of ₹116.8m as well as receivables valued at ₹1.17b due within 12 months. So its liabilities total ₹1.48b more than the combination of its cash and short-term receivables.

Since publicly traded Premier Explosives shares are worth a total of ₹24.8b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Premier Explosives's net debt is sitting at a very reasonable 1.5 times its EBITDA, while its EBIT covered its interest expense just 6.7 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. On the other hand, Premier Explosives saw its EBIT drop by 4.7% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is Premier Explosives'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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Premier Explosives created free cash flow amounting to 9.9% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Premier Explosives's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. But on the bright side, its ability to to handle its total liabilities isn't too shabby at all. We think that Premier Explosives's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For example, we've discovered 1 warning sign for Premier Explosives that you should be aware of before investing here.

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.