Howard Marks put it well when he said that, rather than worrying about fluctuations in share prices, ‘the potential for permanent loss is the risk I worry about…and every practical investor Whom I know, I worry. So it may be clear 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 Hg Infra Engineering Limited (NSE: HGINFRA) uses debt in its business. But is this debt a concern for shareholders?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily pay it off, either by raising capital or with its own cash flow. Integral to capitalism is a process of ‘creative destruction’ where failing businesses are mercilessly liquidated by their bankers. However, a more common (but still costly) situation is where a company must dilute at a cheaper share price to shareholders in order to get debt under control. Having said that, the most common situation is one where a company manages its debt prudently — and to its own advantage. When we think about a company’s use of debt, we first look at cash and debt together.
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What is the debt of HG Infra Engineering?
You can click on the graphic below for historical numbers, but it shows that HG Infra Engineering had ₹14.3b in debt as of September 2022, an increase of ₹9.17b in one year. On the other hand, it has ₹1.75 billion in cash, leaving it with a net debt of around ₹12.5 billion.
HG Infra Engineering’s liabilities at a glance
As of the last reported balance sheet, HG Infra Engineering had liabilities of ₹9.32 Billion in trailing 12 months, and liabilities of ₹11.7 Billion for the trailing 12 months. Offsetting these liabilities, it had cash of ₹1.75B as well as receivables worth ₹9.44B due within 12 months. Hence its total liabilities are more than ₹9.88 billion, which is more than its cash and near-term receivables.
The loss is not that bad as HG Infra Engineering is valued at ₹36.2B, and thus can raise enough capital to strengthen its balance sheet if needed. However, its ability to service the debt is still worth considering.
To size a company’s debt relative to its earnings, we calculate its net debt by multiplying its earnings before interest, taxes, depreciation, and amortization (EBITDA) and earnings before interest and taxes (EBIT) by its interest. divided by expenses (EBIT). its interest cover). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest cover ratio).
HG Infra Engineering’s net debt at 1.7 times its EBITDA is very reasonable, while its EBIT covered its interest expense only 7.0 times last year. While these numbers don’t alarm us, it’s worth noting that the company’s cost of debt is having a real impact. And we also warmly note that HG Infra Engineering grew its EBIT by 13% last year, making its debt load more manageable. When analyzing debt levels, the balance sheet is an obvious place to start. But it is HG Infra Engineering’s earnings that will influence how the balance sheet stacks up in the future. So when considering a loan, it’s definitely worth looking at the earning potential. Click here for Interactive Snapshot.
Finally, while the tax-man may prefer accounting profits, lenders only accept cold hard cash. So we always check how much EBIT is translated into free cash flow. Over the past three years, HG Infra Engineering saw substantial negative free cash flow overall. While this may result in increased spending, it also makes the loan much riskier.
HG Infra Engineering’s struggle to convert EBIT to free cash flow had us second-guessing the strength of its balance sheet, but the other data-points we considered were relatively redeeming. For example, its EBIT growth rate is relatively strong. Looking at all the above angles, we feel that HG Infra Engineering is a somewhat risky investment due to its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this credit risk is worth keeping in mind. There’s no doubt that we learn the most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. For example – HG Infra Engineering has 2 warning signs We think you should know.
If, after all that, you’re more interested in a fast-growing company with a rock-solid balance sheet, then without further delay check out our Net Cash Growth Stocks list.
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find out whether Hg Infra Engineering potentially overpriced or underpriced by checking out our comprehensive analysis, which includes Fair Value Estimates, Risks and Warnings, Dividends, Insider Trading and Financial Health.
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This article from Simply Wall St is general in nature. We only provide commentary based on historical data and analyst forecasts using an unbiased methodology and our articles are not intended to provide financial advice. It is not a recommendation to buy or sell any stock, and does not take into account your objectives, or your financial situation. We aim to bring you long term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall Street has no position in any of the stocks mentioned.