David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. 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 can see that AKG Exim Limited (NSE:AKG) uses debt in its business. But should shareholders worry about its use of debt?
What risk does debt carry?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. If things go really bad, lenders can take over the business. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for AKG Exim
What is AKG Exim’s debt?
The image below, which you can click on for more details, shows that as of March 2022, AKG Exim had a debt of ₹127.0m, up from ₹100.5m in a year. However, he also had ₹22.3 million in cash, and hence his net debt is ₹104.6 million.
How healthy is AKG Exim’s balance sheet?
According to the latest published balance sheet, AKG Exim had liabilities of ₹214.0 million due within 12 months and liabilities of ₹4.61 million due beyond 12 months. On the other hand, it had cash of ₹22.3 million and ₹323.1 million in receivables due within one year. He can therefore boast of having 126.8 million more liquid assets than total Passives.
This excess liquidity is an excellent indication that AKG Exim’s balance sheet is almost as strong as Fort Knox’s. With that in mind, one could argue that its track record means the company is capable of dealing with some adversity.
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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
AKG Exim’s debt is 3.5 times its EBITDA, and its EBIT covers its interest charges 3.3 times. This suggests that while debt levels are significant, we will refrain from labeling them problematic. Notably, AKG Exim’s EBIT has remained fairly stable over the past year, which is not ideal given the leverage. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; because AKG Exim will need income 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 company can only repay its debts with cold hard cash, not with book profits. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past two years, AKG Exim has had substantial negative free cash flow, overall. While investors no doubt expect a reversal of this situation in due course, this clearly means that its use of debt is more risky.
Our point of view
Based on what we’ve seen, AKG Exim doesn’t find it easy, given its EBIT to free cash flow conversion, but the other factors we’ve considered give us cause for optimism. In particular, we’re blown away by his total passive level. When we consider all the factors mentioned above, we feel a bit cautious about AKG Exim’s use of debt. While we understand that debt can improve returns on equity, we suggest shareholders keep a close eye on their level of debt, lest it increase. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example, we found 4 warning signs for AKG Exim (2 are concerning!) that you should be aware of before investing here.
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.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
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.