We Think Sagardeep Alloys (NSE:SAGARDEEP) 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 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 Sagardeep Alloys Limited (NSE:SAGARDEEP) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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, 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Sagardeep Alloys

What Is Sagardeep Alloys's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Sagardeep Alloys had ₹123.3m of debt, an increase on ₹118.1m, over one year. However, because it has a cash reserve of ₹32.1m, its net debt is less, at about ₹91.2m.

How Healthy Is Sagardeep Alloys' Balance Sheet?

The latest balance sheet data shows that Sagardeep Alloys had liabilities of ₹159.4m due within a year, and liabilities of ₹25.5m falling due after that. Offsetting these obligations, it had cash of ₹32.1m as well as receivables valued at ₹136.4m due within 12 months. So it has liabilities totalling ₹16.4m more than its cash and near-term receivables, combined.

Of course, Sagardeep Alloys has a market capitalization of ₹526.2m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

Sagardeep Alloys's debt is 2.8 times its EBITDA, and its EBIT cover its interest expense 3.7 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. One redeeming factor for Sagardeep Alloys is that it turned last year's EBIT loss into a gain of ₹25m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sagardeep Alloys will need earnings to service that debt. 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 the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Sagardeep Alloys generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Sagardeep Alloys's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its interest cover. All these things considered, it appears that Sagardeep Alloys can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Sagardeep Alloys (2 are concerning) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.