Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, V-Guard Industries Limited (NSE:VGUARD) is in debt. But the more important question is: what risk does this debt create?
When is debt a problem?
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. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, many companies use debt to finance their growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for V-Guard Industries
What is V-Guard Industries net debt?
The image below, which you can click on for more details, shows that V-Guard Industries had a debt of ₹117.9 million at the end of March 2022, a reduction from ₹130.1 million on a year. However, his balance sheet shows that he holds ₹612.7 million in cash, so he actually has ₹494.7 million in net cash.
How healthy is V-Guard Industries’ balance sheet?
According to the latest published balance sheet, V-Guard Industries had liabilities of ₹6.16 billion due within 12 months and liabilities of ₹678.0 million due beyond 12 months. As compensation for these obligations, it had cash of ₹612.7 million as well as receivables valued at ₹4.86 billion due within 12 months. Thus, its liabilities total ₹1.37 billion more than the combination of its cash and short-term receivables.
This situation indicates that V-Guard Industries’ balance sheet looks quite strong, as its total liabilities roughly equal its cash. It is therefore highly unlikely that the ₹93.9bn company will run out of cash, but it is still worth keeping an eye on the balance sheet. Despite its notable liabilities, V-Guard Industries has a net cash position, so it’s fair to say that it doesn’t have a lot of debt!
The good news is that V-Guard Industries increased its EBIT by 5.7% year-on-year, which should ease any worries about debt repayment. There is no doubt that we learn the most about debt from the balance sheet. But future earnings, more than anything, will determine V-Guard Industries’ ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a company cannot pay off its debts with paper profits; he needs cash. Although V-Guard Industries has net cash on its balance sheet, it is always worth looking at its ability to convert earnings before interest and taxes (EBIT) to free cash flow, to help us understand how quickly it builds (or erodes) this cash balance. Over the past three years, V-Guard Industries has created free cash flow of 6.1% of its EBIT, an uninspiring performance. This low level of cash conversion compromises its ability to manage and repay its debt.
We could understand if investors are worried about the liabilities of V-Guard Industries, but we can take comfort in the fact that it has a net cash position of ₹494.7 million. On top of that, it has increased its EBIT by 5.7% over the last twelve months. We are therefore not concerned about the use of debt by V-Guard Industries. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. To do this, you need to find out about the 3 warning signs we spotted with V-Guard Industries (including 1 that is concerning).
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
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.