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 Genus Power Infrastructures Limited (NSE:GENUSPOWER) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Genus Power Infrastructures's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2021 Genus Power Infrastructures had debt of ₹2.40b, up from ₹1.76b in one year. However, it does have ₹2.90b in cash offsetting this, leading to net cash of ₹497.4m.
How Healthy Is Genus Power Infrastructures' Balance Sheet?
The latest balance sheet data shows that Genus Power Infrastructures had liabilities of ₹4.39b due within a year, and liabilities of ₹489.6m falling due after that. On the other hand, it had cash of ₹2.90b and ₹5.78b worth of receivables due within a year. So it actually has ₹3.80b more liquid assets than total liabilities.
It's good to see that Genus Power Infrastructures has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Genus Power Infrastructures boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Genus Power Infrastructures's load is not too heavy, because its EBIT was down 21% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is Genus Power Infrastructures's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Genus Power Infrastructures 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 last three years, Genus Power Infrastructures recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While we empathize with investors who find debt concerning, you should keep in mind that Genus Power Infrastructures has net cash of ₹497.4m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of ₹420m, being 90% of its EBIT. So we don't think Genus Power Infrastructures's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Genus Power Infrastructures has 2 warning signs we think you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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.