The external fund manager, backed by Charlie Munger of Berkshire Hathaway, Li Lu, makes no bones about it when he says, “The biggest investment risk is not price volatility, but whether you will suffer permanent capital losses.” When we think about how risky a business is, we always like to look at the use of debt, as over-indebtedness can lead to ruin. As with many other companies Rajratan Global Wire Limited (NSE:RAJRATAN) takes advantage of debt. But should shareholders be concerned about using debt?
When is debt a problem?
In general, debt only becomes a real problem if a company cannot easily pay it off, either by raising capital or using its own cash flow. An essential part of capitalism is the process of ‘creative destruction’, in which failed companies are mercilessly liquidated by their bankers. While not too common, we often see indebted companies permanently diluting their shareholders as lenders force them to raise capital at a difficult price. That said, the most common situation is for a company to manage its debt fairly well – and for its own benefit. When we examine debt levels, we first look at both cash and debt levels together.
What is Rajratan Global Wire’s Net Debt?
The chart below, which you can click on for more details, shows that Rajratan Global Wire had ₹1.43 billion in debt in March 2021; about the same as the year before. However, it does have 75.0 million in cash to offset this, leading to a net debt of approximately ₹1.35 billion.
A Look at Rajratan Global Wire’s Commitments
According to the latest reported balance sheet, Rajratan Global Wire had liabilities of 1.43 billion with a maturity of 12 months and liabilities of ₹699.2 million with a maturity of more than 12 months. This was offset by ₹ 75.0 million in cash and ₹ 1.17 billion in receivables due within 12 months. It thus has liabilities totaling 883.6 million more than its cash and short-term receivables combined.
Of course, Rajratan Global Wire has a market cap of 11.1 billion, so these liabilities are likely to be manageable. That said, it is clear that we must continue to monitor the balance, so as not to deteriorate.
We measure a company’s indebtedness relative to its earning capital by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and by calculating how easily its earnings before interest and taxes (EBIT) offset interest. cover costs (interest cover). So we consider debt in relation to earnings, both with and without depreciation and amortization costs.
While Rajratan Global Wire’s low debt-to-EBITDA ratio of 1.5 suggests only modest use of debt, the fact that last year’s EBIT only covered interest charges 5.8 times gives us pause. But the interest payments are certainly enough to make us think about how affordable his debt is. It’s worth noting that Rajratan Global Wire’s EBIT skyrocketed after rain, rising 39% over the past 12 months. That will make it easier to manage his debts. There is no doubt that we learn the most about debt from the balance sheet. But it is Rajratan Global Wire’s earnings that will affect how the balance sheet holds up going forward. So if you want to know more about the earnings, it might be worth checking out this graph of the long-term profit trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we need to see clearly whether that EBIT leads to a corresponding free cash flow. Overall, Rajratan Global Wire has recorded cash outflows over the past three years. Debt is usually more expensive and almost always riskier in the hands of a company with negative free cash flow. Shareholders can hope for improvement.
According to our analysis, Rajratan Global Wire’s EBIT growth should indicate that it will not have too many problems with its debt. Our other observations, however, were not so encouraging. To be specific, it seems to be about as good at converting EBIT into free cash flow as wet socks are at keeping your feet warm. Considering all of the above elements, it seems to us that Rajratan Global Wire is managing its debt quite well. But a word of warning: we think debt levels are high enough to warrant continued monitoring. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside within the balance sheet – far from it. For example – Rajratan Global Wire has: 3 warning signs we think you should be aware of this.
Are you more interested in a fast-growing company with a strong balance sheet, then take a look our list of net cash growth stocks without delay.
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