Is Supreme Industries (NSE:SUPREMEIND) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 can see that The Supreme Industries Limited (NSE:SUPREMEIND) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

View our latest analysis for Supreme Industries

What Is Supreme Industries's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Supreme Industries had debt of ₹743.9m, up from ₹437.4m in one year. However, it does have ₹6.83b in cash offsetting this, leading to net cash of ₹6.09b.

A Look At Supreme Industries' Liabilities

We can see from the most recent balance sheet that Supreme Industries had liabilities of ₹12.5b falling due within a year, and liabilities of ₹1.98b due beyond that. Offsetting these obligations, it had cash of ₹6.83b as well as receivables valued at ₹5.90b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.71b.

This state of affairs indicates that Supreme Industries' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹430.7b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Supreme Industries boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Supreme Industries saw its EBIT decline by 6.8% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Supreme Industries's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Supreme 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. Looking at the most recent three years, Supreme Industries recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Supreme Industries has ₹6.09b in net cash. So we don't have any problem with Supreme Industries's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in Supreme Industries, you may well want to click here to check an interactive graph of its earnings per share history.

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.