Shree Rama Multi-Tech (NSE:SHREERAMA) Has A Somewhat Strained Balance Sheet

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. We note that Shree Rama Multi-Tech Limited (NSE:SHREERAMA) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Shree Rama Multi-Tech

What Is Shree Rama Multi-Tech's Net Debt?

The image below, which you can click on for greater detail, shows that Shree Rama Multi-Tech had debt of ₹786.4m at the end of March 2020, a reduction from ₹1.06b over a year. On the flip side, it has ₹22.6m in cash leading to net debt of about ₹763.9m.

A Look At Shree Rama Multi-Tech's Liabilities

We can see from the most recent balance sheet that Shree Rama Multi-Tech had liabilities of ₹246.9m falling due within a year, and liabilities of ₹714.9m due beyond that. Offsetting this, it had ₹22.6m in cash and ₹194.9m in receivables that were due within 12 months. So its liabilities total ₹744.4m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the ₹411.9m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Shree Rama Multi-Tech would likely require a major re-capitalisation if it had to pay its creditors today.

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 a net debt to EBITDA ratio of 5.2, it's fair to say Shree Rama Multi-Tech does have a significant amount of debt. However, its interest coverage of 2.7 is reasonably strong, which is a good sign. Looking on the bright side, Shree Rama Multi-Tech boosted its EBIT by a silky 91% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shree Rama Multi-Tech 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 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. Happily for any shareholders, Shree Rama Multi-Tech actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

We feel some trepidation about Shree Rama Multi-Tech's difficulty level of total liabilities, but we've got positives to focus on, too. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. Taking the abovementioned factors together we do think Shree Rama Multi-Tech's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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 example, we've discovered 4 warning signs for Shree Rama Multi-Tech (2 can't be ignored!) that you should be aware of before investing here.

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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