Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Apar Industries Limited (NSE:APARINDS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Apar Industries's Net Debt?
The image below, which you can click on for greater detail, shows that Apar Industries had debt of ₹2.60b at the end of March 2019, a reduction from ₹3.63b over a year. But on the other hand it also has ₹4.00b in cash, leading to a ₹1.41b net cash position.
A Look At Apar Industries's Liabilities
Zooming in on the latest balance sheet data, we can see that Apar Industries had liabilities of ₹36.4b due within 12 months and liabilities of ₹1.80b due beyond that. On the other hand, it had cash of ₹4.00b and ₹22.0b worth of receivables due within a year. So its liabilities total ₹12.2b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Apar Industries has a market capitalization of ₹21.6b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Apar Industries boasts net cash, so it's fair to say it does not have a heavy debt load!
If Apar Industries can keep growing EBIT at last year's rate of 17% over the last year, then it will find its debt load easier to manage. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Apar Industries's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Apar Industries may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Apar Industries produced sturdy free cash flow equating to 64% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While Apar Industries does have more liabilities than liquid assets, it also has net cash of ₹1.4b. And we liked the look of last year's 17% year-on-year EBIT growth. So we are not troubled with Apar Industries's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Apar Industries insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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