Is Kernex Microsystems (India) (NSE:KERNEX) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Kernex Microsystems (India) Limited (NSE:KERNEX) does use debt in its business. But is this debt a concern to shareholders?

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 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kernex Microsystems (India)

What Is Kernex Microsystems (India)'s Debt?

The image below, which you can click on for greater detail, shows that at March 2021 Kernex Microsystems (India) had debt of ₹202.5m, up from ₹106.7m in one year. On the flip side, it has ₹177.0m in cash leading to net debt of about ₹25.4m.

How Healthy Is Kernex Microsystems (India)'s Balance Sheet?

According to the last reported balance sheet, Kernex Microsystems (India) had liabilities of ₹261.4m due within 12 months, and liabilities of ₹34.0m due beyond 12 months. Offsetting this, it had ₹177.0m in cash and ₹143.2m in receivables that were due within 12 months. So it can boast ₹24.8m more liquid assets than total liabilities.

This surplus suggests that Kernex Microsystems (India) has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Kernex Microsystems (India) has a very low debt to EBITDA ratio of 0.66 so it is strange to see weak interest coverage, with last year's EBIT being only 1.6 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Notably, Kernex Microsystems (India) made a loss at the EBIT level, last year, but improved that to positive EBIT of ₹23m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kernex Microsystems (India) 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 it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Kernex Microsystems (India) actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Kernex Microsystems (India)'s conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its interest cover. Taking all this data into account, it seems to us that Kernex Microsystems (India) takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. Be aware that Kernex Microsystems (India) is showing 4 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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