Does Sundaram-Clayton (NSE: SUNCLAYLTD) have a healthy track record?
Warren Buffett said: “Volatility is far from synonymous with risk”. 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. Like many other companies Sundaram-Clayton Limited (NSE: SUNCLAYLTD) uses debt. But the most important question is: what risk does this debt create?
Why Does Debt Bring Risk?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. 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. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
See our latest review for Sundaram-Clayton
How much debt does Sundaram-Clayton have?
You can click on the graph below for historical figures, but it shows that in March 2021, Sundaram-Clayton had 125.6 billion yen in debt, an increase from 120.2 billion yen on a year. On the other hand, it has 16.1 billion yen in cash, resulting in net debt of around 109.5 billion yen.
Is Sundaram-Clayton’s track record healthy?
We can see from the most recent balance sheet that Sundaram-Clayton had liabilities of 114.7 billion yen due within one year and liabilities of 73.0 billion yen beyond. On the other hand, he had 16.1 billion yen in cash and 74.8 billion yen in receivables due within one year. Its liabilities therefore total 96.8 billion euros more than the combination of its cash and short-term receivables.
When you consider that this shortfall exceeds the company’s 74.5b market cap, you may well be inclined to take a close look at the balance sheet. Hypothetically, an extremely high dilution would be necessary if the company were forced to repay its debts by raising capital at the current share price.
We use two main ratios to inform us about the levels of debt compared to earnings. 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). 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).
While Sundaram-Clayton’s debt-to-EBITDA ratio (4.8) suggests that it is using some debt, its interest coverage is very low, at 2.1, suggesting high leverage. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. Given the debt load, it is not ideal that Sundaram-Clayton’s EBIT has been fairly stable over the past twelve months. The balance sheet is clearly the area you need to focus on when analyzing debt. But you can’t look at debt in isolation; since Sundaram-Clayton will need income to pay off this debt. So if you want to know more about its profits, it might be worth checking out this long term profit trend chart.
Finally, a business can only repay its debts with hard cash, not with book profits. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, Sundaram-Clayton has experienced substantial total negative free cash flow. While this may be the result of spending on growth, it makes debt much riskier.
Our point of view
To be frank, Sundaram-Clayton’s interest coverage and track record of converting EBIT to free cash flow makes us rather uncomfortable with its debt levels. That said, his ability to increase his EBIT is not that much of a concern. After looking at the data points discussed, we believe Sundaram-Clayton has too much debt. This kind of risk is acceptable to some, but it certainly does not float our boat. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 3 warning signs for Sundaram-Clayton you should be aware of this, and 2 of them should not be ignored.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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