David Iben put it well when he said, âVolatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. Like many other companies Kamdhenu Limited (NSE: KAMDHENU) uses debt. But the most important question is: what risk does this debt create?
When is Debt a Problem?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. If things really go wrong, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a business’s debt levels is to consider its cash flow and debt together.
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How many debts does Kamdhenu have?
You can click on the graph below for historical figures, but it shows Kamdhenu had 882.9 million yen in debt in September 2021, up from 1.07 billion yen a year earlier. However, he also had 131.0 million yen in cash, so his net debt is 751.9 million yen.
How strong is Kamdhenu’s balance sheet?
The latest balance sheet data shows Kamdhenu had debts of 1.99 billion yen due within one year, and debts of 373.4 million yen due thereafter. In compensation for these obligations, he had cash of 131.0 million as well as receivables valued at 2.10 million maturing within 12 months. It therefore has liabilities totaling 137.5 million euros more than its combined cash and short-term receivables.
Of course, Kamdhenu has a market cap of 5.64 billion yen, so this liability is probably manageable. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) covers its interests. costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Looking at its net debt on EBITDA of 1.3 and its interest coverage of 4.8 times, it seems to us that Kamdhenu is probably using its debt in a fairly reasonable way. We therefore recommend that you keep a close eye on the impact of financing costs on the business. It should be noted that Kamdhenu’s EBIT has soared like bamboo after the rain, gaining 72% in the past twelve months. This will make it easier to manage your debt. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in isolation; since Kamdhenu will need income to repay this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Kamdhenu has recorded free cash flow of 37% of its EBIT, which is lower than expected. It’s not great when it comes to paying down debt.
Our point of view
Kamdhenu’s EBIT growth rate suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. But frankly, we think its conversion from EBIT to free cash flow undermines that impression a bit. When we consider the above range of factors, it seems Kamdhenu is pretty reasonable with his use of debt. This means that they are taking a bit more risk, in the hope of increasing shareholder returns. When analyzing debt levels, the balance sheet is the obvious place to start. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 2 warning signs for Kamdhenu which you should know before investing here.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.