These 4 Measures Indicate That Transformers and Rectifiers (India) (NSE:TRIL) Is Using Debt Reasonably Well

Stock Analysis

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Transformers and Rectifiers (India) Limited (NSE:TRIL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Transformers and Rectifiers (India)

You can click the graphic below for the historical numbers, but it shows that Transformers and Rectifiers (India) had ₹2.36b of debt in September 2022, down from ₹2.73b, one year before. However, it also had ₹293.9m in cash, and so its net debt is ₹2.07b.

Zooming in on the latest balance sheet data, we can see that Transformers and Rectifiers (India) had liabilities of ₹5.66b due within 12 months and liabilities of ₹839.7m due beyond that. On the other hand, it had cash of ₹293.9m and ₹4.64b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.56b.

This deficit isn't so bad because Transformers and Rectifiers (India) is worth ₹7.15b, and thus could probably raise enough capital to shore up 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Even though Transformers and Rectifiers (India)'s debt is only 2.3, its interest cover is really very low at 2.2. This does suggest the company is paying fairly high interest rates. Either way there's no doubt the stock is using meaningful leverage. Also relevant is that Transformers and Rectifiers (India) has grown its EBIT by a very respectable 22% in the last year, thus enhancing its ability to pay down debt. 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Transformers and Rectifiers (India) actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

The good news is that Transformers and Rectifiers (India)'s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its interest cover. Taking all this data into account, it seems to us that Transformers and Rectifiers (India) takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Transformers and Rectifiers (India) (2 are a bit concerning) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Find out whether Transformers and Rectifiers (India) is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Transformers and Rectifiers (India) Limited, together with its subsidiaries, manufactures and sells transformers in India.

Solid track record with mediocre balance sheet.