David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Like many other companies Om Infra Limited (NSE:OMINFRAL) uses debt. But the more important question is: what risk does this debt create?
What risk does debt carry?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up 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 step when considering a company’s debt levels is to consider its cash and debt together.
See our latest analysis for Om Infra
What is Om Infra’s net debt?
The image below, which you can click on for more details, shows that as of September 2021, Om Infra had a debt of ₹1.47 billion, up from ₹1.30 billion in one year. However, he has ₹485.6 million in cash to offset this, resulting in a net debt of around ₹984.2 million.
A look at the responsibilities of Om Infra
Zooming in on the latest balance sheet data, we can see that Om Infra had liabilities of ₹4.46 billion due within 12 months and liabilities of ₹668.2 million due beyond. As compensation for these obligations, it had cash of ₹485.6 million as well as receivables valued at ₹2.26 billion due within 12 months. Thus, its liabilities total ₹2.38 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 Om Infra has a market capitalization of ₹4.93 billion, and so it could probably bolster its balance sheet by raising capital if needed. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Even though Om Infra’s debt is only 2.0, its interest coverage is really very low at 2.5. This leads us to wonder if the company is paying high interest because it is considered risky. Regardless, there is no doubt that the stock uses significant leverage. Om Infra increased its EBIT by 4.4% over the past year. It’s far from amazing, but it’s a good thing when it comes to paying down debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is Om Infra’s profits that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
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, Om Infra has actually had a cash outflow, overall. Debt is generally more expensive and almost always riskier in the hands of a company with negative free cash flow. Shareholders should hope for an improvement.
Our point of view
At first glance, Om Infra’s interest coverage left us hesitant about the stock, and its EBIT to free cash flow conversion was no more appealing than the single empty restaurant on the busiest night in the world. ‘year. But at least its EBIT growth rate isn’t that bad. Once we consider all of the above factors together, it seems to us that Om Infra’s debt makes it a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. 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 outside of the balance sheet. For example Om Infra a 5 warning signs (and 1 that can’t be ignored) that we think you should know about.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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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.