The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Electrozink Public Joint-Stock Company (MCX:ELTZ) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 think about a company's use of debt, we first look at cash and debt together.
What Is Electrozink's Debt?
As you can see below, Electrozink had ₽2.53b of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has ₽228.8m in cash leading to net debt of about ₽2.30b.
How Healthy Is Electrozink's Balance Sheet?
We can see from the most recent balance sheet that Electrozink had liabilities of ₽2.92b falling due within a year, and liabilities of ₽48.5m due beyond that. Offsetting these obligations, it had cash of ₽228.8m as well as receivables valued at ₽263.3m due within 12 months. So its liabilities total ₽2.48b more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the ₽235.2m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Electrozink would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Electrozink'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.
In the last year Electrozink wasn't profitable at an EBIT level, but managed to grow its revenue by 125%, to ₽2.4b. So there's no doubt that shareholders are cheering for growth
While we can certainly appreciate Electrozink's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost a very considerable ₽60m at the EBIT level. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Sure, the company might have a nice story about how they are going on to a brighter future. But the fact is that it incinerated ₽78m of cash in the last twelve months, and has precious few liquid assets in comparison to its liabilities. So we consider this a high risk stock, and we're worried its share price could sink faster than than a dingy with a great white shark attacking it. 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. Case in point: We've spotted 4 warning signs for Electrozink you should be aware of, and 2 of them are concerning.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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