Here's Why Sarda Energy & Minerals (NSE:SARDAEN) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Sarda Energy & Minerals Limited (NSE:SARDAEN) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sarda Energy & Minerals

What Is Sarda Energy & Minerals's Net Debt?

As you can see below, Sarda Energy & Minerals had ₹13.8b of debt at September 2022, down from ₹15.2b a year prior. However, it also had ₹6.76b in cash, and so its net debt is ₹7.02b.

A Look At Sarda Energy & Minerals' Liabilities

The latest balance sheet data shows that Sarda Energy & Minerals had liabilities of ₹7.99b due within a year, and liabilities of ₹12.8b falling due after that. On the other hand, it had cash of ₹6.76b and ₹5.93b worth of receivables due within a year. So it has liabilities totalling ₹8.12b more than its cash and near-term receivables, combined.

Sarda Energy & Minerals has a market capitalization of ₹32.4b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Sarda Energy & Minerals has a low net debt to EBITDA ratio of only 0.57. And its EBIT covers its interest expense a whopping 11.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. And we also note warmly that Sarda Energy & Minerals grew its EBIT by 19% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is Sarda Energy & Minerals's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Sarda Energy & Minerals's free cash flow amounted to 43% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that Sarda Energy & Minerals's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. When we consider the range of factors above, it looks like Sarda Energy & Minerals is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. Be aware that Sarda Energy & Minerals is showing 1 warning sign in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.