Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We note that Jash Engineering Limited (NSE:JASH) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
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. If things go really bad, lenders can take over the business. 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 Jash Engineering
What is Jash Engineering’s debt?
You can click on the graph below for historical figures, but it shows that in March 2022, Jash Engineering had a debt of ₹756.0 million, an increase from ₹650.9 million, on a year. However, he also had ₹267.3 million in cash, and hence his net debt is ₹488.8 million.
How strong is Jash Engineering’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Jash Engineering had liabilities of ₹1.60 billion due within 12 months and liabilities of ₹225.8 million due beyond. In return, he had ₹267.3 million in cash and ₹1.35 billion in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of ₹208.6 million.
Given that publicly traded Jash Engineering shares are worth a total of ₹7.16 billion, it seems unlikely that this level of liabilities will pose a major threat. But there are enough liabilities that we certainly recommend that shareholders continue to monitor the balance sheet in the future.
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). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
While Jash Engineering’s low debt-to-EBITDA ratio of 1.0 suggests only modest use of debt, the fact that EBIT only covered interest expense by 4.3 times last year makes think. We therefore recommend that you closely monitor the impact of financing costs on the business. The bad news is that Jash Engineering has seen its EBIT drop 15% over the past year. If income continues to decline at this rate, managing debt will be harder than taking three kids under 5 to a diner in fancy pants. When analyzing debt levels, the balance sheet is the obvious starting point. But it is the profits of Jash Engineering 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.
Finally, while the taxman may love accounting profits, lenders only accept cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Jash Engineering’s free cash flow has been 37% of its EBIT, less than we expected. This low cash conversion makes debt management more difficult.
Our point of view
Jash Engineering’s struggle to increase EBIT made us doubt the strength of its balance sheet, but the other data points we considered were relatively rewarding. But on the bright side, its ability to manage its debt, based on its EBITDA, isn’t too bad at all. We think Jash Engineering’s debt makes it a bit risky, after looking at the aforementioned data points together. This isn’t necessarily a bad thing, since leverage can increase return on equity, but it is something to be aware of. 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 – Jash Engineering has 2 warning signs we think you should know.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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.