We believe Signet Industries (NSE: SIGIND) is taking risks with its debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” It is only natural to consider a company’s balance sheet when considering how risky it is, as debt is often involved when a business collapses. We can see that Bookmark Industries Limited (NSE: SIGIND) uses debt in his business. But the most important question is: what risk does this debt create?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own 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 costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. 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 business’s debt levels is to consider its cash flow and debt together.

Check out our latest review for Signet Industries

What is Signet Industries’ net debt?

The image below, which you can click for more details, shows that in September 2021 Signet Industries was in debt of 3.04 billion yen, up from 2.42 billion yen in a year. On the other hand, it has 126.6 million yen in cash, resulting in net debt of around 2.91 billion yen.

NSEI: SIGIND History of debt to equity December 10, 2021

How healthy is Signet Industries’ balance sheet?

According to the latest published balance sheet, Signet Industries had liabilities of 4.67 billion yen due within 12 months and liabilities of 791.7 million yen due beyond 12 months. On the other hand, he had 126.6 million yen in cash and 3.55 billion yen worth of claims due within one year. It therefore has liabilities totaling 1.78 billion yen more than its combined cash and short-term receivables.

Since this deficit is actually greater than the company’s market cap of 1.23 billion yen, we think shareholders should really watch Signet Industries’ debt levels, like a parent watching their child do. cycling for the first time. Hypothetically, extremely high dilution would be required 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 earnings 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 compared to EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

While we’re not worried about Signet Industries’ net debt to EBITDA ratio of 4.4, we do think its ultra-low 1.4 times interest coverage is a sign of high leverage. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company in recent times. However, a buyout factor is that Signet Industries has increased its EBIT to 13% over the past 12 months, increasing its ability to manage its debt. When analyzing debt levels, the balance sheet is the obvious place to start. But it is the profits of Signet Industries that will influence the balance sheet in the future. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.

Finally, while the IRS may love accounting profits, lenders only accept hard cash. The logical step is therefore to examine the proportion of this EBIT that corresponds to the actual free cash flow. Over the past three years, Signet Industries has recorded free cash flow representing 59% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.

Our point of view

At first glance, Signet Industries’ level of total liabilities left us hesitant about the stock, and its interest coverage was no more attractive than the only restaurant empty on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign and makes us more optimistic. Looking at the big picture, it seems clear to us that Signet Industries’ use of debt creates risks for the business. If all goes well it may pay off, but the downside to this debt is a greater risk of permanent losses. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 4 warning signs for Signet Industries (2 of which cannot be ignored!) that you should know.

At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is 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 documents. Simply Wall St has no position in any of the stocks mentioned.

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