David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that FRS limited (NSE:SRF) has debt on its balance sheet. But should shareholders worry about its use of debt?
When is debt a problem?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
See our latest analysis for SRF
How much debt does the SRF bear?
As you can see below, at the end of March 2022, the SRF had ₹36.9 billion in debt, up from ₹33.9 billion a year ago. Click on the image for more details. On the other hand, he has ₹7.76 billion in cash, resulting in a net debt of around ₹29.2 billion.
How strong is SRF’s balance sheet?
We can see from the most recent balance sheet that the SRF had liabilities of ₹44.4 billion due within a year, and liabilities of ₹27.7 billion due beyond. In return, he had ₹7.76 billion in cash and ₹18.0 billion in receivables due within 12 months. It therefore has liabilities totaling ₹46.3 billion more than its cash and short-term receivables, combined.
Given that SRF has a market capitalization of ₹660.3 billion, it is hard to believe that these liabilities pose a threat. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
SRF’s net debt is only 0.94 times its EBITDA. And its EBIT covers its interest charges 22.3 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. On top of that, we are happy to report that SRF has increased its EBIT by 53%, reducing the specter of future debt repayments. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether SRF can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the last three years, SRF has recorded free cash flow of 14% of its EBIT, which is really quite low. For us, such a low cash conversion creates a bit of paranoia about the ability to extinguish the debt.
Our point of view
The good news is that SRF’s demonstrated ability to cover its interest charges with its EBIT delights us like a fluffy puppy does a toddler. But, on a darker note, we are a bit concerned about its conversion of EBIT into free cash flow. Given all of this data, it seems to us that the SRF is taking a pretty sensible approach to debt. This means they take on a bit more risk, hoping to increase shareholder returns. Over time, stock prices tend to track earnings per share, so if you’re interested in the SRF, you might want to click here for an interactive chart of its earnings per share history.
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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