These 4 Measures Indicate That Adani Transmission (NSE:ADANITRANS) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Adani Transmission Limited (NSE:ADANITRANS) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Adani Transmission

How Much Debt Does Adani Transmission Carry?

As you can see below, at the end of September 2021, Adani Transmission had ₹287.5b of debt, up from ₹239.8b a year ago. Click the image for more detail. However, it does have ₹16.4b in cash offsetting this, leading to net debt of about ₹271.1b.

How Healthy Is Adani Transmission's Balance Sheet?

We can see from the most recent balance sheet that Adani Transmission had liabilities of ₹57.1b falling due within a year, and liabilities of ₹288.5b due beyond that. On the other hand, it had cash of ₹16.4b and ₹12.3b worth of receivables due within a year. So its liabilities total ₹316.9b more than the combination of its cash and short-term receivables.

Since publicly traded Adani Transmission shares are worth a very impressive total of ₹2.13t, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Adani Transmission shareholders face the double whammy of a high net debt to EBITDA ratio (6.5), and fairly weak interest coverage, since EBIT is just 2.0 times the interest expense. The debt burden here is substantial. More concerning, Adani Transmission saw its EBIT drop by 6.4% in the last twelve months. 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. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Adani Transmission can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Adani Transmission's free cash flow amounted to 27% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Both Adani Transmission's net debt to EBITDA and its interest cover were discouraging. But its not so bad at staying on top of its total liabilities. We should also note that Electric Utilities industry companies like Adani Transmission commonly do use debt without problems. When we consider all the factors discussed, it seems to us that Adani Transmission 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. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Adani Transmission you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.