Elgi Rubber (NSE: ELGIRUBCO) has a somewhat strained record

David Iben put it well when he said: “Volatility 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. Above all, Elgi Rubber Company Limited (NSE: ELGIRUBCO) is in debt. But the most important question is: what risk does this debt create?

What risk does debt entail?

Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that he must raise new equity at low cost, thereby diluting shareholders over the long term. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider both liquidity and debt levels.

See our latest review for Elgi Rubber

What is Elgi Rubber’s net debt?

As you can see below, Elgi Rubber had a debt of 2.43 billion yen in March 2021, up from 2.69 billion yen the previous year. However, he has 100.8 million yen in cash to make up for this, which leads to net debt of around 2.33 billion yen.

How strong is Elgi Rubber’s balance sheet?

We can see from the most recent balance sheet that Elgi Rubber had liabilities of 2.34 billion yen maturing within one year and liabilities of 771.3 million yen beyond. In compensation for these obligations, it had cash of 100.8 million as well as receivables valued at 566.2 million at 12 months. Its liabilities therefore total 2.45 billion euros more than the combination of its cash and short-term receivables.

Given that this deficit is actually greater than the company’s market cap of £ 2.06bn, we believe shareholders should really watch Elgi Rubber’s debt levels, like a parent watching his child riding a bicycle for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely that shareholders would suffer a significant dilution.

We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

Low interest coverage of 0.55 times and an unusually high net debt to EBITDA ratio of 10.4 hit our confidence in Elgi Rubber like a punch in the stomach. This means that we would consider him to be in heavy debt. However, the bright side is that Elgi Rubber achieved a positive EBIT of 63 million euros over the past twelve months, an improvement over the loss of the previous year. There is no doubt that we learn the most about debt from the balance sheet. But it is Elgi Rubber’s earnings that will influence the balance sheet in the future. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.

But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent earnings before interest and taxes (EBIT) are backed by free cash flow. Over the past year, Elgi Rubber has actually generated more free cash flow than EBIT. There is nothing better than cash flow to stay in the good graces of your lenders.

Our point of view

At first glance, Elgi Rubber’s net debt to EBITDA left us hesitant about the stock, and its interest coverage was no more appealing than the only empty restaurant on the busiest night of the year. . But at least it’s pretty decent to convert EBIT into free cash flow; it’s encouraging. Looking at the balance sheet and taking all of these factors into account, we think debt makes Elgi Rubber stock 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 you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for Elgi Rubber (1 of which is potentially serious!) that you should be aware of.

If you are interested in investing in companies that can generate profits without the burden of debt, check out this page 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 shares 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.
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