Is PG Electroplast (NSE:PGEL) Using Too Much Debt?

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. Importantly, PG Electroplast Limited (NSE:PGEL) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for PG Electroplast

What Is PG Electroplast's Debt?

The image below, which you can click on for greater detail, shows that PG Electroplast had debt of ₹2.69b at the end of September 2023, a reduction from ₹4.13b over a year. But it also has ₹3.40b in cash to offset that, meaning it has ₹709.0m net cash.

How Strong Is PG Electroplast's Balance Sheet?

The latest balance sheet data shows that PG Electroplast had liabilities of ₹4.15b due within a year, and liabilities of ₹2.76b falling due after that. On the other hand, it had cash of ₹3.40b and ₹2.02b worth of receivables due within a year. So its liabilities total ₹1.49b more than the combination of its cash and short-term receivables.

Given PG Electroplast has a market capitalization of ₹46.1b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, PG Electroplast boasts net cash, so it's fair to say it does not have a heavy debt load!

Pleasingly, PG Electroplast is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 124% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if PG Electroplast can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While PG Electroplast has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, PG Electroplast burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that PG Electroplast has ₹709.0m in net cash. And we liked the look of last year's 124% year-on-year EBIT growth. So we are not troubled with PG Electroplast's debt use. 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. To that end, you should be aware of the 1 warning sign we've spotted with PG Electroplast .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.