These 4 Measures Indicate That Jaiprakash Power Ventures (NSE:JPPOWER) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 note that Jaiprakash Power Ventures Limited (NSE:JPPOWER) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Jaiprakash Power Ventures

How Much Debt Does Jaiprakash Power Ventures Carry?

The image below, which you can click on for greater detail, shows that Jaiprakash Power Ventures had debt of ₹55.6b at the end of September 2020, a reduction from ₹191.4b over a year. However, it also had ₹3.43b in cash, and so its net debt is ₹52.2b.

How Healthy Is Jaiprakash Power Ventures's Balance Sheet?

According to the last reported balance sheet, Jaiprakash Power Ventures had liabilities of ₹21.0b due within 12 months, and liabilities of ₹54.6b due beyond 12 months. Offsetting this, it had ₹3.43b in cash and ₹6.19b in receivables that were due within 12 months. So its liabilities total ₹66.0b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₹17.4b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Jaiprakash Power Ventures would probably need a major re-capitalization if its creditors were to demand repayment.

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).

Jaiprakash Power Ventures's debt is 4.8 times its EBITDA, and its EBIT cover its interest expense 3.2 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. The good news is that Jaiprakash Power Ventures improved its EBIT by 2.0% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Jaiprakash Power Ventures's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Jaiprakash Power Ventures actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Mulling over Jaiprakash Power Ventures's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Jaiprakash Power Ventures has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Jaiprakash Power Ventures you should be aware of, and 1 of them is a bit unpleasant.

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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