Premier Explosives (NSE:PREMEXPLN) Is Making Moderate Use Of 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.' 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. As with many other companies Premier Explosives Limited (NSE:PREMEXPLN) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Premier Explosives

How Much Debt Does Premier Explosives Carry?

As you can see below, at the end of September 2020, Premier Explosives had ₹601.7m of debt, up from ₹368.7m a year ago. Click the image for more detail. On the flip side, it has ₹76.4m in cash leading to net debt of about ₹525.3m.

How Healthy Is Premier Explosives's Balance Sheet?

According to the last reported balance sheet, Premier Explosives had liabilities of ₹1.06b due within 12 months, and liabilities of ₹144.0m due beyond 12 months. Offsetting these obligations, it had cash of ₹76.4m as well as receivables valued at ₹639.5m due within 12 months. So it has liabilities totalling ₹490.4m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Premier Explosives is worth ₹1.46b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. 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.

Over 12 months, Premier Explosives made a loss at the EBIT level, and saw its revenue drop to ₹1.4b, which is a fall of 42%. That makes us nervous, to say the least.

Caveat Emptor

While Premier Explosives's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at ₹129m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled ₹245m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for Premier Explosives (of which 1 is potentially serious!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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