Is Ratnamani Metals & Tubes (NSE:RATNAMANI) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Ratnamani Metals & Tubes Limited (NSE:RATNAMANI) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. 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.

View our latest analysis for Ratnamani Metals & Tubes

What Is Ratnamani Metals & Tubes's Debt?

As you can see below, at the end of March 2023, Ratnamani Metals & Tubes had ₹2.37b of debt, up from ₹1.57b a year ago. Click the image for more detail. However, it does have ₹1.69b in cash offsetting this, leading to net debt of about ₹677.5m.

How Healthy Is Ratnamani Metals & Tubes' Balance Sheet?

The latest balance sheet data shows that Ratnamani Metals & Tubes had liabilities of ₹8.61b due within a year, and liabilities of ₹2.44b falling due after that. Offsetting these obligations, it had cash of ₹1.69b as well as receivables valued at ₹10.1b due within 12 months. So it actually has ₹744.3m more liquid assets than total liabilities.

Having regard to Ratnamani Metals & Tubes' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹187.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, Ratnamani Metals & Tubes has a very light debt load indeed.

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). 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).

With debt at a measly 0.08 times EBITDA and EBIT covering interest a whopping 33.6 times, it's clear that Ratnamani Metals & Tubes is not a desperate borrower. So relative to past earnings, the debt load seems trivial. In addition to that, we're happy to report that Ratnamani Metals & Tubes has boosted its EBIT by 65%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Ratnamani Metals & Tubes can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Ratnamani Metals & Tubes reported free cash flow worth 5.2% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

The good news is that Ratnamani Metals & Tubes's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Looking at the bigger picture, we think Ratnamani Metals & Tubes's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Ratnamani Metals & Tubes .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.