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.' 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. We can see that Electrozink Public Joint-Stock Company (MCX:ELTZ) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Electrozink's Debt?
The chart below, which you can click on for greater detail, shows that Electrozink had ₽2.53b in debt in December 2020; about the same as the year before. And it doesn't have much cash, so its net debt is about the same.
A Look At Electrozink's Liabilities
We can see from the most recent balance sheet that Electrozink had liabilities of ₽3.06b falling due within a year, and liabilities of ₽48.8m due beyond that. On the other hand, it had cash of ₽13.9m and ₽154.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₽2.94b.
The deficiency here weighs heavily on the ₽240.8m 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'd watch its balance sheet closely, without a doubt. At the end of the day, Electrozink would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Electrozink will need earnings to service that debt. 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 87%, to ₽2.0b. Shareholders probably have their fingers crossed that it can grow its way to profits.
Despite the top line growth, Electrozink still had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping ₽374m. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. 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. 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 3 warning signs for Electrozink you should be aware of.
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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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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