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 synonymous with risk.” It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies HSIL limited (NSE:HSIL) uses debt. But the real question is whether this debt makes the business risky.
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for HSIL
What is HSIL’s debt?
You can click on the graph below for historical figures, but it shows that as of September 2021, HSIL had debt of ₹10.4 billion, an increase from ₹9.30 billion, year on year . However, since he has a cash reserve of ₹264.8 million, his net debt is lower at around ₹10.2 billion.
How healthy is the HSIL balance sheet?
According to the latest published balance sheet, HSIL had liabilities of ₹6.61 billion due within 12 months and liabilities of ₹10.8 billion due beyond 12 months. As compensation for these obligations, it had cash of ₹264.8 million as well as receivables valued at ₹2.21 billion due within 12 months. Thus, its liabilities total ₹14.9 billion more than the combination of its cash and short-term receivables.
This shortfall is sizable compared to its market capitalization of ₹16.8 billion, so it suggests shareholders to monitor HSIL’s use of debt. If its lenders asked it to shore up its balance sheet, shareholders would likely face significant dilution.
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.
HSIL has a debt to EBITDA ratio of 3.2 and its EBIT covered its interest expense 4.1 times. Taken together, this implies that, while we wouldn’t like to see debt levels increase, we think he can manage his current leverage. On the bright side, HSIL has grown its EBIT by 48% over the past year. Like the milk of human kindness, this type of growth increases resilience, making the business more capable of managing debt. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; since HSIL will need revenue 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. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, HSIL has recorded free cash flow of 28% of its EBIT, which is lower than expected. This low cash conversion makes debt management more difficult.
Our point of view
Neither HSIL’s ability to manage its total liabilities nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story and suggests some resilience. From all the angles mentioned above, it seems to us that HSIL is a bit risky investment because of its leverage. Not all risk is bad, as it can increase stock price returns if it pays off, but this leverage risk is worth keeping in mind. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. We have identified 3 warning signs with HSIL, and understanding them should be part of your investment process.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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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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