Is Bharat Road Network (NSE:BRNL) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Bharat Road Network Limited (NSE:BRNL) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Bharat Road Network

What Is Bharat Road Network's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2022 Bharat Road Network had debt of ₹14.9b, up from ₹14.1b in one year. However, it also had ₹609.4m in cash, and so its net debt is ₹14.3b.

How Strong Is Bharat Road Network's Balance Sheet?

The latest balance sheet data shows that Bharat Road Network had liabilities of ₹6.31b due within a year, and liabilities of ₹16.1b falling due after that. On the other hand, it had cash of ₹609.4m and ₹3.88b worth of receivables due within a year. So its liabilities total ₹18.0b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₹3.17b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Bharat Road Network would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Bharat Road Network shareholders face the double whammy of a high net debt to EBITDA ratio (8.8), and fairly weak interest coverage, since EBIT is just 0.64 times the interest expense. This means we'd consider it to have a heavy debt load. The silver lining is that Bharat Road Network grew its EBIT by 915% last year, which nourishing like the idealism of youth. If that earnings trend continues it will make its debt load much more manageable in the future. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Bharat Road Network 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Bharat Road Network produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On the face of it, Bharat Road Network's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. We should also note that Infrastructure industry companies like Bharat Road Network commonly do use debt without problems. Once we consider all the factors above, together, it seems to us that Bharat Road Network's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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, we've discovered 3 warning signs for Bharat Road Network (1 shouldn't be ignored!) that you should be aware of before investing here.

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.