We Think Ramco Systems (NSE:RAMCOSYS) Has A Fair Chunk 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.' 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 Ramco Systems Limited (NSE:RAMCOSYS) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Our analysis indicates that RAMCOSYS is potentially overvalued!

What Is Ramco Systems's Debt?

The image below, which you can click on for greater detail, shows that at September 2022 Ramco Systems had debt of ₹830.0m, up from none in one year. However, it also had ₹253.3m in cash, and so its net debt is ₹576.7m.

How Strong Is Ramco Systems' Balance Sheet?

We can see from the most recent balance sheet that Ramco Systems had liabilities of ₹3.21b falling due within a year, and liabilities of ₹781.3m due beyond that. Offsetting these obligations, it had cash of ₹253.3m as well as receivables valued at ₹1.77b due within 12 months. So its liabilities total ₹1.97b more than the combination of its cash and short-term receivables.

Ramco Systems has a market capitalization of ₹8.41b, 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Ramco Systems's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Ramco Systems had a loss before interest and tax, and actually shrunk its revenue by 19%, to ₹4.9b. That's not what we would hope to see.

Caveat Emptor

While Ramco Systems's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping ₹1.6b. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through ₹582m of cash over the last year. So suffice it to say we consider the stock very risky. For riskier companies like Ramco Systems I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.

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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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.