Adani Transmission (NSE:ADANITRANS) Has A Somewhat Strained Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Adani Transmission Limited (NSE:ADANITRANS) 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 Adani Transmission

What Is Adani Transmission's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Adani Transmission had ₹269.6b of debt, an increase on ₹243.9b, over one year. Net debt is about the same, since the it doesn't have much cash.

A Look At Adani Transmission's Liabilities

Zooming in on the latest balance sheet data, we can see that Adani Transmission had liabilities of ₹64.2b due within 12 months and liabilities of ₹267.9b due beyond that. Offsetting this, it had ₹4.44b in cash and ₹23.2b in receivables that were due within 12 months. So its liabilities total ₹304.4b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Adani Transmission has a huge market capitalization of ₹1.05t, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 2.1 times and a disturbingly high net debt to EBITDA ratio of 6.2 hit our confidence in Adani Transmission like a one-two punch to the gut. The debt burden here is substantial. Even more troubling is the fact that Adani Transmission actually let its EBIT decrease by 8.9% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Adani Transmission's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Adani Transmission recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

To be frank both Adani Transmission's interest cover and its track record of managing its debt, based on its EBITDA, make us rather uncomfortable with its debt levels. But at least its level of total liabilities is not so bad. It's also worth noting that Adani Transmission is in the Electric Utilities industry, which is often considered to be quite defensive. Once we consider all the factors above, together, it seems to us that Adani Transmission'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 Adani Transmission has 2 warning signs (and 1 which is significant) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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