Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. ” So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. We can see that Ramky Infrastructure Limited (NSE: RAMKY) uses debt in its business. But should shareholders be concerned about its use of debt?
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business 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 flow and debt together.
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What is the debt of Ramky Infrastructure?
The image below, which you can click for more details, shows that Ramky Infrastructure had a debt of 7.21 billion yen at the end of September 2021, a reduction from the 20.7 billion yen on a year. However, he also had 3.03 billion yen in cash, so his net debt is 4.18 billion yen.
How healthy is Ramky Infrastructure’s balance sheet?
According to the latest published balance sheet, Ramky Infrastructure had liabilities of 33.3 billion yen due within 12 months and liabilities of 6.53 billion yen due beyond 12 months. On the other hand, he had 3.03 billion yen in cash and 3.53 billion yen in less than one year receivables. Its liabilities therefore total 33.3 billion yen more than the combination of its cash and short-term receivables.
The lack here weighs heavily on the ₹ 10.8b company itself, as if a child struggles under the weight of a huge backpack full of books, his gym gear and a trumpet. So we would be watching its record closely, without a doubt. Ultimately, Ramky Infrastructure would likely need a major recapitalization if its creditors demanded repayment.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we look at debt over earnings with and without amortization charges.
Even though Ramky Infrastructure’s debt is only 1.9, its interest coverage is really very low at 1.1. This makes us wonder if the company pays high interest because it is considered risky. Either way, there’s no doubt that the stock uses significant leverage. Notably, Ramky Infrastructure recorded a loss in EBIT level last year, but improved it to a positive EBIT of 1.9 billion yen in the last twelve months. The balance sheet is clearly the area you need to focus on when analyzing debt. But you can’t look at debt in isolation; since Ramky Infrastructure will need revenue to service this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent earnings before interest and taxes (EBIT) are backed by free cash flow. Fortunately for all shareholders, Ramky Infrastructure has actually generated more free cash flow than EBIT over the past year. This kind of solid money conversion makes us as excited as the crowd when the beat drops at a Daft Punk concert.
Our point of view
To be frank, Ramky Infrastructure’s interest coverage and track record of controlling its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Looking at the balance sheet and taking all of these factors into account, we think debt makes Ramky Infrastructure stock a bit risky. Some people like this kind of risk, but we are aware of the potential pitfalls, so we would probably prefer him to carry less debt. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we discovered 2 warning signs for Ramky infrastructure (1 is potentially serious!) Which you should be aware of before investing here.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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