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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that HPL Electric & Power Limited (NSE:HPL) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 HPL Electric & Power
How Much Debt Does HPL Electric & Power Carry?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 HPL Electric & Power had ₹5.18b of debt, an increase on ₹4.86b, over one year. However, because it has a cash reserve of ₹815.0m, its net debt is less, at about ₹4.36b.
How Strong Is HPL Electric & Power's Balance Sheet?
We can see from the most recent balance sheet that HPL Electric & Power had liabilities of ₹7.45b falling due within a year, and liabilities of ₹461.8m due beyond that. Offsetting this, it had ₹815.0m in cash and ₹4.72b in receivables that were due within 12 months. So its liabilities total ₹2.38b more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of ₹2.62b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
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).