Shreyans Industries (NSE:SHREYANIND) Takes On Some Risk With Its Use Of Debt

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Shreyans Industries Limited (NSE:SHREYANIND) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Shreyans Industries

What Is Shreyans Industries's Net Debt?

As you can see below, at the end of September 2020, Shreyans Industries had ₹588.6m of debt, up from ₹373.5m a year ago. Click the image for more detail. But on the other hand it also has ₹786.2m in cash, leading to a ₹197.6m net cash position.

How Healthy Is Shreyans Industries's Balance Sheet?

We can see from the most recent balance sheet that Shreyans Industries had liabilities of ₹1.11b falling due within a year, and liabilities of ₹636.0m due beyond that. Offsetting these obligations, it had cash of ₹786.2m as well as receivables valued at ₹463.7m due within 12 months. So its liabilities total ₹495.8m more than the combination of its cash and short-term receivables.

Shreyans Industries has a market capitalization of ₹1.15b, 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. While it does have liabilities worth noting, Shreyans Industries also has more cash than debt, so we're pretty confident it can manage its debt safely.

Importantly, Shreyans Industries's EBIT fell a jaw-dropping 78% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shreyans 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. Shreyans Industries may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Shreyans Industries created free cash flow amounting to 15% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While Shreyans Industries does have more liabilities than liquid assets, it also has net cash of ₹197.6m. Despite the cash, we do find Shreyans Industries's EBIT growth rate concerning, so we're not particularly comfortable with the stock. 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 Shreyans Industries that you should be aware of before investing here.

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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