David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Airo Lam Limited (NSE:AIROLAM) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Airo Lam
What Is Airo Lam's Net Debt?
As you can see below, at the end of September 2018, Airo Lam had ₹215.0m of debt, up from ₹201.6m a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.
How Strong Is Airo Lam's Balance Sheet?
We can see from the most recent balance sheet that Airo Lam had liabilities of ₹470.0m falling due within a year, and liabilities of ₹61.0m due beyond that. Offsetting this, it had ₹4.25m in cash and ₹434.3m in receivables that were due within 12 months. So its liabilities total ₹92.4m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Airo Lam has a market capitalization of ₹422.3m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Airo Lam's net debt is sitting at a very reasonable 2.3 times its EBITDA, while its EBIT covered its interest expense just 3.2 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly Airo Lam's EBIT was essentially flat over the last twelve months. Ideally it can diminish its debt load by kick-starting earnings growth. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Airo Lam will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.