Surani Steel Tubes (NSE:SURANI) Use Of Debt Could Be Considered Risky
Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Surani Steel Tubes Limited (NSE:SURANI) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Surani Steel Tubes
How Much Debt Does Surani Steel Tubes Carry?
The image below, which you can click on for greater detail, shows that at March 2019 Surani Steel Tubes had debt of ₹173.2m, up from ₹153.6m in one year. However, it also had ₹19.2m in cash, and so its net debt is ₹153.9m.
A Look At Surani Steel Tubes's Liabilities
The latest balance sheet data shows that Surani Steel Tubes had liabilities of ₹174.1m due within a year, and liabilities of ₹40.2m falling due after that. Offsetting these obligations, it had cash of ₹19.2m as well as receivables valued at ₹63.6m due within 12 months. So it has liabilities totalling ₹131.5m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Surani Steel Tubes has a market capitalization of ₹294.1m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Weak interest cover of 0.89 times and a disturbingly high net debt to EBITDA ratio of 13.9 hit our confidence in Surani Steel Tubes like a one-two punch to the gut. The debt burden here is substantial. Worse, Surani Steel Tubes's EBIT was down 80% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Surani Steel Tubes 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Surani Steel Tubes saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
To be frank both Surani Steel Tubes's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. Having said that, its ability to handle its total liabilities isn't such a worry. Taking into account all the aforementioned factors, it looks like Surani Steel Tubes has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. While Surani Steel Tubes didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away.Click here to see if its earnings are heading in the right direction, over the medium term.
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.
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 editorial-team@simplywallst.com. 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.
