We Think Wonder Electricals (NSE:WEL) Can Stay On Top Of Its 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Wonder Electricals Limited (NSE:WEL) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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, 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.

View our latest analysis for Wonder Electricals

What Is Wonder Electricals's Debt?

You can click the graphic below for the historical numbers, but it shows that Wonder Electricals had ₹206.4m of debt in September 2023, down from ₹215.9m, one year before. And it doesn't have much cash, so its net debt is about the same.

A Look At Wonder Electricals' Liabilities

According to the last reported balance sheet, Wonder Electricals had liabilities of ₹1.05b due within 12 months, and liabilities of ₹70.8m due beyond 12 months. On the other hand, it had cash of ₹1.41m and ₹879.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹235.2m.

Given Wonder Electricals has a market capitalization of ₹7.98b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Wonder Electricals's low debt to EBITDA ratio of 1.00 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.4 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Importantly, Wonder Electricals grew its EBIT by 51% over the last twelve months, and that growth will make it easier to handle 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 Wonder Electricals 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Wonder Electricals saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Wonder Electricals's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its EBIT growth rate. Considering this range of data points, we think Wonder Electricals is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Wonder Electricals (including 1 which shouldn't be ignored) .

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.