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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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Mahamaya Steel Industries Limited (NSE:MAHASTEEL) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
Check out our latest analysis for Mahamaya Steel Industries
What Is Mahamaya Steel Industries's Net Debt?
As you can see below, Mahamaya Steel Industries had ₹1.01b of debt, at March 2019, which is about the same the year before. You can click the chart for greater detail. On the flip side, it has ₹47.6m in cash leading to net debt of about ₹963.0m.
How Healthy Is Mahamaya Steel Industries's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Mahamaya Steel Industries had liabilities of ₹949.5m due within 12 months and liabilities of ₹467.0m due beyond that. On the other hand, it had cash of ₹47.6m and ₹172.8m worth of receivables due within a year. So it has liabilities totalling ₹1.20b more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of ₹1.56b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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.
Mahamaya Steel Industries shareholders face the double whammy of a high net debt to EBITDA ratio (5.1), and fairly weak interest coverage, since EBIT is just 1.2 times the interest expense. This means we'd consider it to have a heavy debt load. Another concern for investors might be that Mahamaya Steel Industries's EBIT fell 17% in the last year. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Mahamaya Steel Industries 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.