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Some say volatility, rather than debt, is the best way to view risk as an investor, but Warren Buffett said “volatility is far from risk.” So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. We notice that Agro Phos (India) Limited (NSE: AGROPHOS) has a debt on its balance sheet. But should shareholders be concerned about its use of debt?
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. If things really go wrong, lenders can take over the business. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, many companies use debt to finance their growth without negative consequences. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest analysis for Agro Phos (India)
What is the debt of Agro Phos (India)?
The image below, which you can click for more details, shows that Agro Phos (India) had a debt of 131.1 million at the end of March 2021, a reduction from 182.8 million over one year. However, it has 45.4 million euros in cash offsetting this, which leads to net debt of around 85.7 million euros.
How strong is Agro Phos (India) balance sheet?
According to the latest published balance sheet, Agro Phos (India) had debts of 267.4 million yen due within 12 months and debts of 42.8 million yen due beyond 12 months. In compensation for these obligations, it had cash of 45.4 million as well as receivables valued at 190.0 million at 12 months. Thus, its liabilities exceed by 74.8 M and the sum of its cash and its receivables (short term).
While that may sound like a lot, it’s not that bad since Agro Phos (India) has a market capitalization of 302.1 million euros, and could therefore likely strengthen its balance sheet by raising capital if needed. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
While Agro Phos (India) ‘s low debt-to-EBITDA ratio of 1.3 suggests modest use of debt, the fact that EBIT only covered interest expense 2.8 times over the past year makes think. But the interest payments are certainly enough to make us think about how affordable his debt is. Shareholders should know that the EBIT of Agro Phos (India) fell 22% last year. If this profit trend continues, paying off debt will be about as easy as driving cats on a roller coaster. When analyzing debt levels, the balance sheet is the obvious starting point. But it is the results of Agro Phos (India) that will influence the performance of the balance sheet in the future. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Agro Phos (India) has generated strong free cash flow equivalent to 65% of its EBIT, roughly what we expected. This hard cash allows him to reduce his debt whenever he wants.
Our point of view
Agro Phos (India) ‘s EBIT growth rate was a real negative on this analysis, although other factors we took into account cast it in a significantly better light. For example, its conversion from EBIT to free cash flow is relatively strong. From all the angles mentioned above, it seems to us that Agro Phos (India) is a somewhat risky investment because of its debt. Not all risks are bad, as they can increase stock returns if they are profitable, but this risk of leverage is worth keeping in mind. The balance sheet is clearly the area you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for Agro Phos (India) (1 of which is a bit unpleasant!) to know.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
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This Simply Wall St article is general in nature. 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 material. Simply Wall St has no position in any of the stocks mentioned.
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