These 4 Measures Indicate That Responsive Industries (NSE:RESPONIND) Is Using Debt Safely

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Responsive Industries Limited (NSE:RESPONIND) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Responsive Industries

What Is Responsive Industries's Net Debt?

As you can see below, at the end of September 2020, Responsive Industries had ₹1.60b of debt, up from ₹1.25b a year ago. Click the image for more detail. On the flip side, it has ₹371.7m in cash leading to net debt of about ₹1.23b.

How Healthy Is Responsive Industries' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Responsive Industries had liabilities of ₹3.11b due within 12 months and liabilities of ₹239.8m due beyond that. On the other hand, it had cash of ₹371.7m and ₹3.44b worth of receivables due within a year. So it actually has ₹464.5m more liquid assets than total liabilities.

Having regard to Responsive Industries' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹46.5b company is short on cash, but still worth keeping an eye on the balance sheet.

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).

While Responsive Industries's low debt to EBITDA ratio of 1.1 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.0 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Pleasingly, Responsive Industries is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 349% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Responsive Industries'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Responsive Industries actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

The good news is that Responsive Industries's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Overall, we don't think Responsive Industries is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. 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 instance, we've identified 1 warning sign for Responsive Industries that you should be aware of.

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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