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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. 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. We note that Surani Steel Tubes Limited (NSE:SURANI) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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 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. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Surani Steel Tubes
How Much Debt Does Surani Steel Tubes Carry?
The image below, which you can click on for greater detail, shows that at March 2019 Surani Steel Tubes had debt of ₹173.2m, up from ₹153.6m in one year. However, it also had ₹19.2m in cash, and so its net debt is ₹153.9m.
A Look At Surani Steel Tubes's Liabilities
The latest balance sheet data shows that Surani Steel Tubes had liabilities of ₹174.1m due within a year, and liabilities of ₹40.2m falling due after that. Offsetting these obligations, it had cash of ₹19.2m as well as receivables valued at ₹63.6m due within 12 months. So it has liabilities totalling ₹131.5m more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Surani Steel Tubes has a market capitalization of ₹294.1m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).