Why Cellecor Gadgets (NSE:CELLECOR) is able to manage its debt responsibly.

Li Lu, an external fund manager backed by Berkshire Hathaway’s Charlie Munger, has stated clearly that “the biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.” When we think about how risky a company is, we always look at its use of debt, because too much debt can lead to ruin. Like many other companies, Selecor Gadgets Limited (NSE:CELLECOR) does use debt, but the more important question is: how much risk is that debt creating?

Why is debt risky?

Debt props up a company until the company has trouble paying it off, either with new capital or free cash flow. Ultimately, if a company can’t meet its legal obligations to repay its debt, shareholders may get nothing. However, a more common (but still painful) scenario is that a company has to raise new equity capital at a low price, thereby permanently diluting shareholders’ equity. Of course, plenty of companies use debt to fund growth; it’s not without negative implications. When examining debt levels, we first consider both cash and debt levels.

Check out our latest analysis for Cellecor Gadgets

How much net debt does Cellecor Gadgets have?

As you can see below, at the end of March 2024, Cellecor Gadgets had debt of ₹747.4m, up from ₹208.4m a year ago – click the image for more details – but on the other hand it has ₹44.5m in cash, leading to net debt of about ₹703m.

How strong is Cellecor Gadgets’ balance sheet?

The latest balance sheet data shows that Cellecor Gadgets had liabilities of ₹954.7m due within a year, and liabilities of ₹4.46m due beyond that. Offsetting this, it had cash of ₹44.5m and receivables of ₹189.0m due within 12 months. This means that its liabilities exceed the sum of its cash and (near-term) receivables by ₹725.6m.

Cellecor Gadgets has a publicly traded market capitalization of ₹5.92b, so this level of debt is unlikely to pose a significant threat, although we do think it’s worth keeping an eye on the strength of its balance sheet, as this may change over time.

We use two main ratios to look at debt levels relative to earnings: the first is net debt divided by earnings before interest, tax, depreciation and amortization (EBITDA), and the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or interest cover for short).This way we take into account both the absolute quantum of debt as well as the interest paid on it.

Cellecor Gadgets’ net debt is at a very reasonable level of 2.4 times its EBITDA, and its EBIT covered its interest expenses just 3.9 times last year. While these figures don’t make us anxious, it’s worth noting that the company’s cost of debt is actually having an impact. Pleasingly, Cellecor Gadgets’ EBIT has been growing faster than former Australian Prime Minister Bob Hawke can down a yard glass, boasting an increase of 129% over the last twelve months. When analysing debt, it’s obvious to look at the balance sheet. But debt can’t be viewed in complete isolation, as Cellecor Gadgets needs earnings to pay down its debt. So if you want to understand more about the company’s earnings, it might be worth checking this graph showing the long term earnings trend.

Finally, while tax authorities may love accounting profits, lenders only accept cash. So the logical step is to look at the proportion of EBIT that is matched by actual free cash flow. Over the last three years, Cellecor Gadgets has had significant negative free cash flow in total. Investors will no doubt be hoping that this situation will reverse at some point, but it clearly means that the company’s use of debt is riskier.

Our take

While Cellecor Gadgets’ conversion of EBIT to free cash flow was really negative in this analysis, the other factors we considered were pretty good. There’s no doubt that its ability to grow EBIT is pretty good. Looking at all this data, we feel a bit cautious about Cellecor Gadgets’ debt levels. We understand that debt boosts return on equity, but shareholders may want to monitor debt levels closely to make sure they don’t rise. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, all companies can have risks that exist outside the balance sheet. It’s safe to say that Cellecor Gadgets is a bit cautious about its debt levels. 4 Warning Signs in Investment Analysis Two of them can’t be ignored…

After all, sometimes it’s easier to focus on companies that don’t need debt, and readers can access our list of growth stocks with zero net debt. 100% Freeright now.

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