ITI (NSE:ITI) seems to be using debt quite wisely

Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We notice that ITI limited (NSE:ITI) has debt on its balance sheet. But the real question is whether this debt makes the business risky.

What risk does debt carry?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. The first step when considering a company’s debt levels is to consider its cash and debt together.

See our latest analysis for ITI

What is ITI’s debt?

The image below, which you can click on for more details, shows that ITI had debt of ₹13.9 billion at the end of September 2021, a reduction from ₹14.9 billion year on year. However, he also had ₹2.97 billion in cash, and hence his net debt is ₹11.0 billion.

NSEI: ITI Debt to Equity History January 25, 2022

A Look at ITI’s Responsibilities

The latest balance sheet data shows that ITI had liabilities of ₹59.5 billion due within a year, and liabilities of ₹4.69 billion falling due thereafter. In return, he had ₹2.97 billion in cash and ₹48.8 billion in receivables due within 12 months. Thus, its liabilities total ₹12.3 billion more than the combination of its cash and short-term receivables.

Of course, ITI has a market cap of ₹105.8 billion, so those liabilities are probably manageable. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

ITI shareholders face the double whammy of a high net debt to EBITDA ratio (5.4) and quite low interest coverage, as EBIT is only 1.2 times expenses of interests. The debt burden here is considerable. A redeeming factor for ITI is that it turned last year’s EBIT loss into a gain of ₹1.6 billion, over the last twelve months. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; since ITI will need revenue to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.

Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore important to check how much of its earnings before interest and taxes (EBIT) converts into actual free cash flow. Over the past year, ITI has actually produced more free cash flow than EBIT. There’s nothing better than incoming money to stay in the good books of your lenders.

Our point of view

We weren’t impressed with ITI’s net debt to EBITDA ratio, and its interest coverage made us cautious. But its conversion from EBIT to free cash flow has been significantly rewarding. When we consider all the factors mentioned above, we feel a bit cautious about ITI’s use of debt. While we understand that debt can improve returns on equity, we suggest shareholders keep a close eye on their level of debt, lest it increase. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 4 warning signs for ITI you should be aware, and 2 of them are a bit unpleasant.

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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John A. Bogar