Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. As with many other companies Ratnamani Metals & Tubes Limited (NSE:RATNAMANI) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
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How Much Debt Does Ratnamani Metals & Tubes Carry?
As you can see below, at the end of September 2023, Ratnamani Metals & Tubes had ₹1.77b of debt, up from ₹1.37b a year ago. Click the image for more detail. However, its balance sheet shows it holds ₹2.92b in cash, so it actually has ₹1.14b net cash.
A Look At Ratnamani Metals & Tubes’ Liabilities
The latest balance sheet data shows that Ratnamani Metals & Tubes had liabilities of ₹5.77b due within a year, and liabilities of ₹2.48b falling due after that. On the other hand, it had cash of ₹2.92b and ₹7.77b worth of receivables due within a year. So it actually has ₹2.44b more liquid assets than total liabilities.
This state of affairs indicates that Ratnamani Metals & Tubes’ balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it’s very unlikely that the ₹219.5b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Ratnamani Metals & Tubes boasts net cash, so it’s fair to say it does not have a heavy debt load!
On top of that, Ratnamani Metals & Tubes grew its EBIT by 52% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Ratnamani Metals & Tubes’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. While Ratnamani Metals & Tubes has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Ratnamani Metals & Tubes reported free cash flow worth 4.5% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Ratnamani Metals & Tubes has net cash of ₹1.14b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 52% over the last year. So we don’t think Ratnamani Metals & Tubes’s use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We’ve spotted 1 warning sign for Ratnamani Metals & Tubes you should be aware of.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
