Lux Industries (NSE:LUXIND) seems to be using debt quite wisely

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Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to 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. Like many other companies Lux Industries Limited (NSE:LUXIND) uses debt. But should shareholders worry about its use of debt?

When is debt dangerous?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, many companies use debt to finance their growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.

Discover our latest analysis for Lux Industries

What is Lux Industries’ net debt?

As you can see below, at the end of September 2021, Lux Industries had ₹1.86 billion in debt, up from ₹941.9 million a year ago. Click on the image for more details. However, he has ₹1.55 billion in cash to offset this, resulting in a net debt of around ₹310.4 million.

NSEI: LUXIND Debt to Equity History March 7, 2022

A look at the liabilities of Lux Industries

According to the latest published balance sheet, Lux Industries had liabilities of ₹5.79 billion due within 12 months and liabilities of ₹447.8 million due beyond 12 months. In return, he had ₹1.55 billion in cash and ₹5.79 billion in receivables due within 12 months. So he actually has ₹1.11 billion Continued liquid assets than total liabilities.

This state of affairs indicates that the balance sheet of Lux Industries seems quite solid, since its total liabilities are approximately equal to its liquidities. It is therefore highly unlikely that the ₹71.5bn company will run out of cash, but it is still worth keeping an eye on the balance sheet. Having virtually no net debt, Lux Industries has very little debt.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.

Lux Industries has very little debt (net of cash) and has a debt/EBITDA ratio of 0.064 and an EBIT of 125 times interest expense. Thus, compared to previous income, the level of indebtedness seems insignificant. Even better, Lux Industries increased its EBIT by 107% last year, which is an impressive improvement. If sustained, this growth will make debt even more manageable in years to come. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; since Lux Industries will need revenue to repay this debt. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the last three years, Lux Industries has recorded a free cash flow of 27% of its EBIT, which is weaker than expected. It’s not great when it comes to paying off debt.

Our point of view

Lux Industries’ interest coverage suggests they can manage their debt as easily as Cristiano Ronaldo could score a goal against an Under-14 keeper. But truth be told, we think his conversion of EBIT to free cash flow somewhat undermines that impression. Zooming out, Lux Industries seems to be using debt quite sensibly; and that gets the green light from us. Although debt carries risks, when used wisely, it can also generate a higher return on equity. 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, Lux Industries has 4 warning signs (and 1 that shouldn’t be ignored) that we think you should know about.

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.

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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