Tarmat (NSE: TARMAT) has a somewhat strained balance sheet

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Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of capital. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We notice that Tarmat Limited (NSE: TARMAT) has a debt on its balance sheet. But the most important question is: what risk does this debt create?

When Is Debt a Problem?

Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. If things really go wrong, lenders can take over the business. 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. Of course, many companies use debt to finance their growth without negative consequences. When we think of a business’s use of debt, we first look at cash flow and debt together.

Discover our latest analysis for Tarmat

What is Tarmat’s debt?

As you can see below, Tarmat had 894.7m in debt in March 2021, up from 1.10m the year before. However, it has 147.0M in cash offsetting this, leading to net debt of around 747.7M.

NSEI: TARMAT History of debt on equity July 19, 2021

Is Tarmat’s balance sheet healthy?

Zooming in on the latest balance sheet data, we can see that Tarmat had a liability of 802.7 million yen due within 12 months and a liability of 909.9 million yen beyond. On the other hand, it had cash of 147.0 M and receivables worth 907.9 M within one year. It therefore has liabilities totaling 657.7 million yen more than its cash and short-term receivables combined.

This deficit is substantial compared to its market capitalization of 1.04 billion euros, so he suggests shareholders keep an eye on Tarmat’s use of debt. This suggests that shareholders would be heavily diluted if the company needed to consolidate its balance sheet quickly.

We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt over EBITDA) and the actual interest charges associated with this debt (with its interest coverage rate). ).

The weak interest coverage of 1.9 times and an unusually high net debt / EBITDA ratio of 10.5 affected our confidence in Tarmat like a punch in the stomach. The debt burden here is considerable. Worse yet, Tarmat has seen its reservoir EBIT by 44% over the past 12 months. If the income continues like this for the long term, there is an incredible chance to pay off that debt. There is no doubt that we learn the most about debt from the balance sheet. But it is Tarmat’s profits 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.

But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past two years, Tarmat has recorded free cash flow of 29% of its EBIT, which is lower than expected. It’s not great when it comes to paying down debt.

Our point of view

To be frank, Tarmat’s net debt to EBITDA and its history of (not) growing its EBIT makes us rather uncomfortable with its debt levels. And besides, his total passive level also fails to inspire confidence. We are pretty clear that we consider Tarmat to be really quite risky, because of the health of its balance sheet. For this reason, we are quite cautious on the stock, and we believe that shareholders should closely monitor its liquidity. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. We have identified 3 warning signs with Tarmat (at least 1 which makes us a little uncomfortable), and understanding them should be part of your investment process.

If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.

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