Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies Jindal Poly Films Limited (NSE:JINDALPOLY) uses debt. But does this debt worry shareholders?

What risk does debt carry?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, many companies use debt to finance their growth, without any negative consequences. When we look at debt levels, we first consider cash and debt levels, together.

See our latest review for Jindal Poly Films

How much debt does Jindal Poly Films have?

You can click on the graph below for historical figures, but it shows that in March 2022, Jindal Poly Films had a debt of ₹12.6 billion, an increase from ₹9.16 billion, on a year. On the other hand, he has ₹5.54 billion in cash, resulting in a net debt of around ₹7.07 billion.

How strong is Jindal Poly Films’ balance sheet?

According to the latest published balance sheet, Jindal Poly Films had liabilities of ₹11.8 billion due within 12 months and liabilities of ₹15.6 billion due beyond 12 months. On the other hand, it had a cash position of ₹5.54 billion and ₹2.09 billion in receivables due within a year. It therefore has liabilities totaling ₹19.8 billion more than its cash and short-term receivables, combined.

Jindal Poly Films has a market capitalization of ₹45.6 billion, so it could very likely raise funds to improve its balance sheet, should the need arise. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Jindal Poly Films’ net debt is only 0.50 times its EBITDA. And its EBIT easily covers its interest charges, which is 44.4 times the size. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Also positive, Jindal Poly Films has increased its EBIT by 24% over the past year, which should make it easier to pay down debt in the future. The balance sheet is clearly the area to focus on when analyzing debt. But it is the profits of Jindal Poly Films that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.

Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Jindal Poly Films has recorded free cash flow of 33% of EBIT, which is lower than expected. This low cash conversion makes debt management more difficult.

Our point of view

Jindal Poly Films’ interest coverage suggests he can manage his debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. But truth be told, we think his conversion of EBIT to free cash flow somewhat undermines that impression. All told, it looks like Jindal Poly Films can comfortably handle its current level of debt. Of course, while this leverage can improve return on equity, it comes with more risk, so it’s worth keeping an eye out for. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. We have identified 2 warning signs with Jindal Poly Films (at least 1, which makes us a little uneasy), and understanding them should be part of your investment process.

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.