These 4 Measures Indicate That Commercial Engineers & Body Builders Co (NSE:CEBBCO) Is Using Debt Reasonably Well
Simply Wall St
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Commercial Engineers & Body Builders Co Limited (NSE:CEBBCO) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Commercial Engineers & Body Builders Co's Net Debt?
As you can see below, Commercial Engineers & Body Builders Co had ₹450.9m of debt at March 2019, down from ₹509.1m a year prior. However, because it has a cash reserve of ₹257.7m, its net debt is less, at about ₹193.1m.
NSEI:CEBBCO Historical Debt, September 13th 2019
A Look At Commercial Engineers & Body Builders Co's Liabilities
Zooming in on the latest balance sheet data, we can see that Commercial Engineers & Body Builders Co had liabilities of ₹498.4m due within 12 months and liabilities of ₹628.9m due beyond that. On the other hand, it had cash of ₹257.7m and ₹253.3m worth of receivables due within a year. So it has liabilities totalling ₹616.2m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Commercial Engineers & Body Builders Co has a market capitalization of ₹1.24b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Even though Commercial Engineers & Body Builders Co's debt is only 1.6, its interest cover is really very low at 0.14. In large part that's it has so much depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) Either way there's no doubt the stock is using meaningful leverage. We also note that Commercial Engineers & Body Builders Co improved its EBIT from a last year's loss to a positive ₹23m. When analysing debt levels, the balance sheet is the obvious place to start. But it is Commercial Engineers & Body Builders Co's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, Commercial Engineers & Body Builders Co actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our View
Commercial Engineers & Body Builders Co's interest cover was a real negative on this analysis, although the other factors we considered were considerably better In particular, we are dazzled with its conversion of EBIT to free cash flow. Looking at all this data makes us feel a little cautious about Commercial Engineers & Body Builders Co's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Commercial Engineers & Body Builders Co insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
