Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. We note that Transformers and Rectifiers (India) Limited (NSE:TRIL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Transformers and Rectifiers (India)
As you can see below, at the end of March 2022, Transformers and Rectifiers (India) had ₹3.25b of debt, up from ₹2.68b a year ago. Click the image for more detail. On the flip side, it has ₹136.0m in cash leading to net debt of about ₹3.11b.
According to the last reported balance sheet, Transformers and Rectifiers (India) had liabilities of ₹6.72b due within 12 months, and liabilities of ₹742.3m due beyond 12 months. Offsetting these obligations, it had cash of ₹136.0m as well as receivables valued at ₹5.31b due within 12 months. So it has liabilities totalling ₹2.02b more than its cash and near-term receivables, combined.
Transformers and Rectifiers (India) has a market capitalization of ₹6.35b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. 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).
While we wouldn't worry about Transformers and Rectifiers (India)'s net debt to EBITDA ratio of 4.1, we think its super-low interest cover of 2.0 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. The good news is that Transformers and Rectifiers (India) improved its EBIT by 6.4% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. There's no doubt that we learn most about debt from the balance sheet. But it is Transformers and Rectifiers (India)'s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Transformers and Rectifiers (India) produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Transformers and Rectifiers (India)'s struggle to cover its interest expense with its EBIT had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its conversion of EBIT to free cash flow is relatively strong. Looking at all the angles mentioned above, it does seem to us that Transformers and Rectifiers (India) is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Transformers and Rectifiers (India) has 3 warning signs (and 1 which is potentially serious) we think you should know about.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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Transformers and Rectifiers (India) Limited, together with its subsidiaries, manufactures and sells transformers in India.
The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.
Read more about these checks in the individual report sections or in our analysis model.
Questionable track record with imperfect balance sheet.
Simply Wall St's Editorial Team provides unbiased, factual reporting on global stocks using in-depth fundamental analysis.
Find out more about our editorial guidelines and team.
Transformers and Rectifiers (India) Limited, together with its subsidiaries, manufactures and sells transformers in India.
The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.
Read more about these checks in the individual report sections or in our analysis model.
Questionable track record with imperfect balance sheet.
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