Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Jindal Steel & Power Limited (NSE:JINDALSTEL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
View our latest analysis for Jindal Steel & Power
What Is Jindal Steel & Power’s Debt?
You can click the graphic below for the historical numbers, but it shows that Jindal Steel & Power had ₹240.1b of debt in September 2020, down from ₹321.1b, one year before. On the flip side, it has ₹10.8b in cash leading to net debt of about ₹229.3b.
How Healthy Is Jindal Steel & Power’s Balance Sheet?
The latest balance sheet data shows that Jindal Steel & Power had liabilities of ₹254.3b due within a year, and liabilities of ₹281.2b falling due after that. Offsetting this, it had ₹10.8b in cash and ₹31.0b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹493.7b.
This deficit casts a shadow over the ₹314.5b company, like a colossus towering over mere mortals. So we’d watch its balance sheet closely, without a doubt. After all, Jindal Steel & Power would likely require a major re-capitalisation if it had to pay its creditors today.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Even though Jindal Steel & Power’s debt is only 2.1, its interest cover is really very low at 2.4. This does have us wondering if the company pays high interest because it is considered risky. In any case, it’s safe to say the company has meaningful debt. Pleasingly, Jindal Steel & Power is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 345% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Jindal Steel & Power’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Jindal Steel & Power actually produced more free cash flow than EBIT. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
While Jindal Steel & Power’s level of total liabilities has us nervous. For example, its conversion of EBIT to free cash flow and EBIT growth rate give us some confidence in its ability to manage its debt. We think that Jindal Steel & Power’s debt does make it a bit risky, after considering the aforementioned data points together. That’s not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Jindal Steel & Power has 4 warning signs (and 2 which shouldn’t be ignored) we think you should know about.
If, after all that, you’re more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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