Is Texmo Pipes and Products (NSE:TEXMOPIPES) Using Too Much 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.' 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 Texmo Pipes and Products Limited (NSE:TEXMOPIPES) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Texmo Pipes and Products

What Is Texmo Pipes and Products's Debt?

The image below, which you can click on for greater detail, shows that Texmo Pipes and Products had debt of ₹170.0m at the end of September 2021, a reduction from ₹456.0m over a year. However, it also had ₹98.3m in cash, and so its net debt is ₹71.7m.

How Healthy Is Texmo Pipes and Products' Balance Sheet?

According to the last reported balance sheet, Texmo Pipes and Products had liabilities of ₹924.4m due within 12 months, and liabilities of ₹250.0m due beyond 12 months. Offsetting these obligations, it had cash of ₹98.3m as well as receivables valued at ₹540.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹535.2m.

While this might seem like a lot, it is not so bad since Texmo Pipes and Products has a market capitalization of ₹2.19b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With net debt sitting at just 0.20 times EBITDA, Texmo Pipes and Products is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 7.5 times the interest expense over the last year. On top of that, Texmo Pipes and Products grew its EBIT by 83% over the last twelve months, and that growth will make it easier to handle 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 Texmo Pipes and Products 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Texmo Pipes and Products actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

The good news is that Texmo Pipes and Products's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Considering this range of factors, it seems to us that Texmo Pipes and Products is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. 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 Texmo Pipes and Products is showing 2 warning signs in our investment analysis , you should know about...

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.