Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Kabra Extrusiontechnik Limited (NSE:KABRAEXTRU) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Kabra Extrusiontechnik's Debt?
The image below, which you can click on for greater detail, shows that at March 2019 Kabra Extrusiontechnik had debt of ₹94.3m, up from ₹40.7m in one year. However, it does have ₹158.4m in cash offsetting this, leading to net cash of ₹64.1m.
How Strong Is Kabra Extrusiontechnik's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Kabra Extrusiontechnik had liabilities of ₹937.9m due within 12 months and liabilities of ₹26.7m due beyond that. On the other hand, it had cash of ₹158.4m and ₹463.6m worth of receivables due within a year. So its liabilities total ₹342.7m more than the combination of its cash and short-term receivables.
Since publicly traded Kabra Extrusiontechnik shares are worth a total of ₹1.98b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Kabra Extrusiontechnik also has more cash than debt, so we're pretty confident it can manage its debt safely.
It is just as well that Kabra Extrusiontechnik's load is not too heavy, because its EBIT was down 49% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kabra Extrusiontechnik will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Kabra Extrusiontechnik has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Kabra Extrusiontechnik recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for and improvement.
While Kabra Extrusiontechnik does have more liabilities than liquid assets, it also has net cash of ₹64m. So although we see some areas for improvement, we're not too worried about Kabra Extrusiontechnik's balance sheet. Given our hesitation about the stock, it would be good to know if Kabra Extrusiontechnik insiders have sold any shares recently. You click here to find out if insiders have sold recently.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.