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 risk.” It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. We note that Vaswani Industries Limited (NSE: VASWANI) has debt on its balance sheet. But should shareholders be worried about its use of debt?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we look at debt levels, we first consider both liquidity and debt levels.
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What is the debt of Vaswani Industries?
As you can see below, Vaswani Industries was owed 532.2 million yen in September 2021, which is roughly the same as the year before. You can click on the graph for more details. However, he also had 72.8 million yen in cash, so his net debt is 459.4 million yen.
How strong is Vaswani Industries’ balance sheet?
The latest balance sheet data shows that Vaswani Industries had liabilities of 776.9 million yen due within one year, and liabilities of 170.6 million yen due thereafter. On the other hand, it had cash of 72.8 M and 609.5 M of receivables due within one year. It therefore has liabilities totaling 265.2 million yen more than its combined cash and short-term receivables.
This deficit is considerable compared to its market capitalization of 439.5 M, so he suggests shareholders to keep an eye on the use of debt by Vaswani Industries. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Even though Vaswani Industries’ debt is only 2.3, its interest coverage is really very low at 2.2. This suggests that the company is paying fairly high interest rates. Either way, there’s no doubt that the stock uses significant leverage. It is important to note that the EBIT of Vaswani Industries has fallen by 35% in the last twelve months. If this profit trend continues, paying off debt will be about as easy as keeping cats on a roller coaster. There is no doubt that we learn the most about debt from the balance sheet. But it is the profits of Vaswani Industries that will influence the balance sheet in the future. So if you want to know more about its profits, it might be worth checking out this long term profit trend chart.
Finally, a business can only repay its debts with hard cash, not with book profits. We must therefore clearly examine whether this EBIT leads to the corresponding free cash flow. Over the past two years, Vaswani Industries’ free cash flow has stood at 44% of its EBIT, less than we expected. It’s not great when it comes to paying down debt.
Our point of view
Reflecting on Vaswani Industries’ attempt to (not) increase its EBIT, we are certainly not enthusiastic. That said, its ability to convert EBIT into free cash flow is not that much of a concern. Overall, we think it’s fair to say that Vaswani Industries has enough debt that there is real risk around the balance sheet. If all goes well, it may pay off, but the downside to this debt is an increased risk of permanent losses. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 4 warning signs for Vaswani Industries (2 of which should not be ignored!) that you should know.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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