KKV Agro Powers (NSE:KKVAPOW) Has A Somewhat Strained Balance Sheet

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, KKV Agro Powers Limited (NSE:KKVAPOW) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for KKV Agro Powers

What Is KKV Agro Powers's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 KKV Agro Powers had ₹140.3m of debt, an increase on ₹45.1m, over one year. On the flip side, it has ₹48.4m in cash leading to net debt of about ₹91.9m.

How Strong Is KKV Agro Powers' Balance Sheet?

We can see from the most recent balance sheet that KKV Agro Powers had liabilities of ₹234.6m falling due within a year, and liabilities of ₹54.6m due beyond that. Offsetting this, it had ₹48.4m in cash and ₹27.3m in receivables that were due within 12 months. So its liabilities total ₹213.6m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since KKV Agro Powers has a market capitalization of ₹505.1m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

KKV Agro Powers's net debt is sitting at a very reasonable 1.8 times its EBITDA, while its EBIT covered its interest expense just 3.0 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Sadly, KKV Agro Powers's EBIT actually dropped 9.0% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since KKV Agro Powers 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, KKV Agro Powers's free cash flow amounted to 40% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Both KKV Agro Powers's interest cover and its EBIT growth rate were discouraging. But its not so bad at managing its debt, based on its EBITDA,. When we consider all the factors discussed, it seems to us that KKV Agro Powers is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 5 warning signs for KKV Agro Powers you should be aware of, and 4 of them are a bit unpleasant.

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.