Sadbhav Infrastructure Project (NSE:SADBHIN) Seems To Be Using A Lot Of Debt

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 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, Sadbhav Infrastructure Project Limited (NSE:SADBHIN) does carry debt. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Sadbhav Infrastructure Project

How Much Debt Does Sadbhav Infrastructure Project Carry?

The image below, which you can click on for greater detail, shows that Sadbhav Infrastructure Project had debt of ₹57.9b at the end of September 2020, a reduction from ₹61.2b over a year. However, because it has a cash reserve of ₹2.53b, its net debt is less, at about ₹55.4b.

A Look At Sadbhav Infrastructure Project's Liabilities

Zooming in on the latest balance sheet data, we can see that Sadbhav Infrastructure Project had liabilities of ₹24.2b due within 12 months and liabilities of ₹67.3b due beyond that. Offsetting this, it had ₹2.53b in cash and ₹2.90b in receivables that were due within 12 months. So its liabilities total ₹86.1b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₹7.54b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Sadbhav Infrastructure Project 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). 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).

Weak interest cover of 0.55 times and a disturbingly high net debt to EBITDA ratio of 10.4 hit our confidence in Sadbhav Infrastructure Project like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, Sadbhav Infrastructure Project's EBIT was down 52% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sadbhav Infrastructure Project 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Sadbhav Infrastructure Project recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

To be frank both Sadbhav Infrastructure Project's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. It's also worth noting that Sadbhav Infrastructure Project is in the Infrastructure industry, which is often considered to be quite defensive. After considering the datapoints discussed, we think Sadbhav Infrastructure Project has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 5 warning signs for Sadbhav Infrastructure Project (2 are concerning!) that you should be aware of before investing here.

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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