Karda Constructions (NSE:KARDA) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Karda Constructions Limited (NSE:KARDA) does use debt in its business. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Karda Constructions

How Much Debt Does Karda Constructions Carry?

As you can see below, Karda Constructions had ₹387.1m of debt at March 2021, down from ₹990.6m a year prior. But on the other hand it also has ₹560.9m in cash, leading to a ₹173.8m net cash position.

How Strong Is Karda Constructions' Balance Sheet?

According to the last reported balance sheet, Karda Constructions had liabilities of ₹1.06b due within 12 months, and liabilities of ₹846.8m due beyond 12 months. Offsetting this, it had ₹560.9m in cash and ₹724.7m in receivables that were due within 12 months. So it has liabilities totalling ₹621.6m more than its cash and near-term receivables, combined.

Given Karda Constructions has a market capitalization of ₹11.6b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Karda Constructions also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is well worth noting that Karda Constructions's EBIT shot up like bamboo after rain, gaining 56% in the last twelve months. That'll make it easier 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 Karda Constructions 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Karda Constructions 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. Over the most recent three years, Karda Constructions recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

We could understand if investors are concerned about Karda Constructions's liabilities, but we can be reassured by the fact it has has net cash of ₹173.8m. And we liked the look of last year's 56% year-on-year EBIT growth. So we don't think Karda Constructions's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Karda Constructions , and understanding them should be part of your investment process.

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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