These 4 Measures Indicate That Accuracy Shipping (NSE:ACCURACY) Is Using Debt Extensively

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. Importantly, Accuracy Shipping Limited (NSE:ACCURACY) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Accuracy Shipping

What Is Accuracy Shipping's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Accuracy Shipping had debt of ₹859.3m, up from ₹776.5m in one year. And it doesn't have much cash, so its net debt is about the same.

How Strong Is Accuracy Shipping's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Accuracy Shipping had liabilities of ₹657.6m due within 12 months and liabilities of ₹476.5m due beyond that. Offsetting these obligations, it had cash of ₹13.2m as well as receivables valued at ₹1.32b due within 12 months. So it can boast ₹196.8m more liquid assets than total liabilities.

This luscious liquidity implies that Accuracy Shipping's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

While Accuracy Shipping's debt to EBITDA ratio (3.3) suggests that it uses some debt, its interest cover is very weak, at 1.6, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Even more troubling is the fact that Accuracy Shipping actually let its EBIT decrease by 7.2% over the last year. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Accuracy Shipping will need earnings to service that debt. 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. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Accuracy Shipping burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Both Accuracy Shipping's conversion of EBIT to free cash flow and its interest cover were discouraging. But at least its level of total liabilities is a gleaming silver lining to those clouds. When we consider all the factors discussed, it seems to us that Accuracy Shipping is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. To that end, you should learn about the 4 warning signs we've spotted with Accuracy Shipping (including 2 which is don't sit too well with us) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. 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.
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