Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We can see that Nila Infrastructures Limited (NSE: NILAINFRA) uses debt in its business. But the real question is whether this debt makes the business risky.
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. 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, many companies use debt to finance their growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Nila Infrastructures
What is Nila Infrastructures debt?
You can click on the graph below for historical figures, but it shows Nila Infrastructures had ₹1.08 billion in debt in March 2022, up from ₹1.45 billion a year prior. Net debt is about the same, since she doesn’t have a lot of cash.
A look at the liabilities of Nila Infrastructures
According to the latest published balance sheet, Nila Infrastructures had liabilities of ₹1.92 billion due within 12 months and liabilities of ₹941.7 million due beyond 12 months. In return, he had ₹7.15 million in cash and ₹640.8 million in receivables due within 12 months. Thus, its liabilities total ₹2.21 billion more than the combination of its cash and short-term receivables.
Given that this deficit is actually greater than the company’s market capitalization of ₹2.00 billion, we think shareholders really should be watching Nila Infrastructures’ debt levels, like a parent watching their child do bike for the first time. In theory, extremely large dilution would be required if the company were forced to repay its debts by raising capital at the current share price.
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). Thus, we consider debt to earnings with and without depreciation and amortization charges.
A low interest coverage of 0.37x and an extremely high net debt to EBITDA ratio of 14.9 shook our confidence in Nila Infrastructures like a punch in the gut. This means that we would consider him to be heavily indebted. Worse, the EBIT of Nila Infrastructures fell by 36% compared to last year. If the profits continue like this in the long term, there is an unimaginable chance of repaying this debt. 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 Nila Infrastructures will need revenue to repay this debt. So, if you want to know more about its earnings, it might 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 past three years, Nila Infrastructures has actually produced more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
At first glance, Nila Infrastructures’ interest coverage left us hesitant about the stock, and its EBIT growth rate was no more appealing than the single empty restaurant on the busiest night of the year. But at least it’s decent enough to convert EBIT to free cash flow; it’s encouraging. Overall, it seems to us that the balance sheet of Nila Infrastructures is really a risk for the company. We are therefore almost as suspicious of this stock as a hungry kitten of falling into its owner’s fish pond: once bitten, twice shy, as they say. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Know that Nila Infrastructures presents 4 warning signs in our investment analysis and 2 of them should not be ignored…
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.