Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it seems like smart money knows that debt – which is usually linked to bankruptcies – is a very important factor when you assess the risk of a business. We notice that JMC Projects (India) Limited (NSE: JMCPROJECT) has debts on its balance sheet. But should shareholders be worried about its use of debt?
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. If things really go wrong, lenders can take over the business. However, a more common (but still costly) situation is where a company has to issue shares 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 advantage. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
What is the debt of JMC Projects (India)?
The image below, which you can click for more details, shows that JMC Projects (India) had ₹ 13.4 billion in debt at the end of March 2021, a reduction of ₹ 17.1 billion. ₹ over one year. On the other hand, it has ₹ 2.54 billion in cash, resulting in net debt of around ₹ 10.9 billion.
A look at the responsibilities of JMC Projects (India)
The latest balance sheet data shows that JMC Projects (India) had ₹ 27.8 billion in liabilities due within one year, and ₹ 22.6 billion in liabilities due thereafter. In return, she had ₹ 2.54 billion in cash and ₹ 12.2 billion in receivables due within 12 months. Thus, its liabilities total ₹ 35.7 billion more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the ₹ 17.6 billion company as a towering colossus of mere mortals. We would therefore monitor its record closely, without a doubt. Ultimately, JMC Projects (India) would likely need a major recapitalization if its creditors demanded repayment.
We use two main ratios to tell us about leverage versus earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). In this way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
While JMC Projects (India) has a fairly reasonable net debt to EBITDA multiple of 2.5, its interest coverage appears low at 1.0. This makes us wonder if the company pays high interest because it is considered risky. Either way, it’s safe to say that the business has significant debt. JMC Projects (India) increased its EBIT by 2.0% last year. Even if it does not have much effect on our socks, it is a positive point in terms of debt. There is no doubt that we learn the most about debt from the balance sheet. But you cannot view the debt in total isolation; since JMC Projects (India) will need income to service this debt. So when you consider debt, it’s really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, while the tax authorities love accounting profits, lenders only accept cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Fortunately for all shareholders, JMC Projects (India) has actually produced more free cash flow than EBIT over the past three years. This kind of big cash conversion turns us on as much as the crowd when the beat drops at a Daft Punk concert.
Our point of view
To be frank, both JMC Projects’ (India) interest coverage and track record of controlling its total liabilities make us quite uncomfortable with its debt levels. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Once we consider all of the above factors together, it seems to us that JMC Projects (India) 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. However, not all investment risks lie on the balance sheet – far from it. We have identified 3 warning signs with JMC Projects (India) (at least 1 which does not suit us very well) , and understanding them should be part of your investment process.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
When trading JMC (India) projects or any other investment, use the platform seen by many as the professional’s gateway to the world market, Interactive brokers. You get the cheapest * trading in stocks, options, futures, currencies, bonds and funds worldwide from a single integrated account.
This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim 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 information. Simply Wall St has no position in any of the stocks mentioned.
*Interactive Brokers Ranked Least Expensive Broker By StockBrokers.com Annual Online Review 2020
Do you have any comments on this article? Concerned about the content? Get in touch with us directly. Otherwise, email the editorial team (at) simplywallst.com.