Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that HPL Electric & Power Limited (NSE: HPL) uses debt in its business. But the more important question is: what risk does this debt create?
What risk does debt carry?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for HPL Electric & Power
What is HPL Electric & Power’s debt?
The graph below, which you can click on for more details, shows that HPL Electric & Power had a debt of ₹5.65 billion in March 2022; about the same as the previous year. However, since he has a cash reserve of ₹802.5 million, his net debt is lower at around ₹4.84 billion.
How strong is HPL Electric & Power’s balance sheet?
Latest balance sheet data shows that HPL Electric & Power had liabilities of ₹7.91 billion due within one year, and liabilities of ₹805.4 million falling due thereafter. On the other hand, it had a cash position of ₹802.5 million and ₹5.06 billion in receivables due within a year. Thus, its liabilities total ₹2.86 billion more than the combination of its cash and short-term receivables.
While that might sound like a lot, it’s not that bad since HPL Electric & Power has a market capitalization of ₹4.98 billion, and so it could probably strengthen its balance sheet by raising capital if needed. However, it is always worth taking a close look at its ability to repay debt.
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.
Although we are not concerned about HPL Electric & Power’s net debt to EBITDA ratio of 3.1, we believe that its extremely low interest coverage of 1.5 times is a sign of high leverage. . It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. On the bright side, HPL Electric & Power increased its EBIT by 39% last year. Like the milk of human kindness, this type of growth increases resilience, making the business more capable of managing debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is the profits of HPL Electric & Power that will influence the balance sheet in the future. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, HPL Electric & Power has produced strong free cash flow equivalent to 59% of its EBIT, which is what we expected. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
Based on our analysis, HPL Electric & Power’s EBIT growth rate should indicate that it will not have too many problems with its debt. But the other factors we noted above weren’t so encouraging. To be precise, he seems about as good at covering his interest costs with his EBIT as wet socks are at keeping your feet warm. When we consider all the factors mentioned above, we feel a bit cautious about HPL Electric & Power’s use of debt. While debt has its upside in higher potential returns, we think shareholders should certainly consider how debt levels could make the stock more risky. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we have identified 3 warning signs for HPL Electric & Power (2 are significant) of which you should be aware.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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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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