Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We note that Pearl Global Industries Limited (NSE:PGIL) has debt on its balance sheet. But should shareholders worry about its use of debt?
What risk does debt carry?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. 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.
Check out our latest analysis for Pearl Global Industries
What is Pearl Global Industries net debt?
The image below, which you can click on for more details, shows that as of March 2022, Pearl Global Industries had a debt of ₹5.73 billion, up from ₹3.68 billion in a year. On the other hand, he has ₹1.55 billion in cash, resulting in a net debt of around ₹4.18 billion.
How healthy is Pearl Global Industries’ balance sheet?
According to the latest published balance sheet, Pearl Global Industries had liabilities of ₹9.11 billion due within 12 months and liabilities of ₹2.55 billion due beyond 12 months. In return, he had ₹1.55 billion in cash and ₹4.01 billion in receivables due within 12 months. It therefore has liabilities totaling ₹6.09 billion more than its cash and short-term receivables, combined.
This deficit is sizable compared to its market capitalization of ₹9.31 billion, so it suggests shareholders keep an eye on Pearl Global Industries’ use of debt. If its lenders asked it to shore up its balance sheet, shareholders would likely face significant 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). Thus, we consider debt to earnings with and without amortization and depreciation expense.
While Pearl Global Industries’ debt to EBITDA ratio (3.0) suggests it uses some debt, its interest coverage is very low at 2.0, suggesting high leverage. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company lately. However, shareholders should be reassured to remember that Pearl Global Industries has actually increased its EBIT by 461% over the past 12 months. If this earnings trend continues, it will make its leverage much more manageable in the future. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in total isolation; since Pearl Global Industries will need revenue to repay this debt. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.
Finally, while the taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Pearl Global Industries has burned a lot of cash. While investors no doubt expect a reversal of this situation in due course, it clearly means that its use of debt is more risky.
Our point of view
At first glance, Pearl Global Industries’ interest coverage left us hesitant about the stock, and its EBIT to free cash flow conversion was no more appealing than the single empty restaurant on the busiest night in the world. ‘year. But on the bright side, its EBIT growth rate is a good sign and makes us more optimistic. Once we consider all of the above factors together, it seems to us that Pearl Global Industries’ debt makes it a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Know that Pearl Global Industries shows 3 warning signs in our investment analysis and 2 of them make us uncomfortable…
If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-flowing growth stocks without further ado.
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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.