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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Alicon Castalloy Limited (NSE:ALICON) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Alicon Castalloy
How Much Debt Does Alicon Castalloy Carry?
As you can see below, at the end of March 2019, Alicon Castalloy had ₹3.10b of debt, up from ₹2.42b a year ago. Click the image for more detail. However, it also had ₹81.6m in cash, and so its net debt is ₹3.02b.
How Strong Is Alicon Castalloy's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Alicon Castalloy had liabilities of ₹4.52b due within 12 months and liabilities of ₹1.14b due beyond that. On the other hand, it had cash of ₹81.6m and ₹3.40b worth of receivables due within a year. So its liabilities total ₹2.18b more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Alicon Castalloy is worth ₹5.24b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Alicon Castalloy's net debt is sitting at a very reasonable 2.1 times its EBITDA, while its EBIT covered its interest expense just 3.0 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Alicon Castalloy grew its EBIT by 6.3% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Alicon Castalloy'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.