Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Above all, Ajmera Realty & Infra India Limited (NSE:AJMERA) is in debt. But the more important question is: what risk does this debt create?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for Ajmera Realty & Infra India
How much debt does Ajmera Realty & Infra India have?
The image below, which you can click on for more details, shows that Ajmera Realty & Infra India had debt of ₹6.72 billion at the end of September 2021, a reduction from ₹10.2 billion over a year. However, he also had ₹285.5 million in cash, and hence his net debt is ₹6.44 billion.
How healthy is Ajmera Realty & Infra India’s balance sheet?
The latest balance sheet data shows that Ajmera Realty & Infra India had liabilities of ₹2.41 billion due within one year, and liabilities of ₹7.91 billion falling due thereafter. In return, he had ₹285.5 million in cash and ₹2.13 billion in receivables due within 12 months. Thus, its liabilities total ₹7.90 billion more than the combination of its cash and short-term receivables.
While that might sound like a lot, it’s not that bad as Ajmera Realty & Infra India has a market capitalization of ₹14.5 billion, and so it could probably bolster its balance sheet by raising capital if needed. But we definitely want to keep our eyes peeled for indications that its debt is too risky.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
A low interest coverage of 1.9x and an extremely high net debt to EBITDA ratio of 5.8 shook our confidence in Ajmera Realty & Infra India like a punch in the gut. The debt burden here is considerable. The good news is that Ajmera Realty & Infra India has grown its EBIT smoothly by 51% over the last twelve months. Like the milk of human kindness, this type of growth increases resilience, making the business more capable of managing debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is the profits of Ajmera Realty & Infra India that will influence the balance sheet in the future. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Ajmera Realty & Infra India has recorded free cash flow of 60% of its EBIT, which is about normal given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.
Our point of view
On the balance sheet, the most notable positive for Ajmera Realty & Infra India is the fact that it looks capable of increasing its EBIT with confidence. However, our other observations were not so encouraging. To be precise, it looks about as good at managing debt, based on its EBITDA, as wet socks at keeping your feet warm. When we consider all the factors mentioned above, we feel a bit cautious about Ajmera Realty & Infra India’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. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we have identified 4 warning signs for Ajmera Realty & Infra India (2 are potentially serious) of which you should be aware.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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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.
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