Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We can see that Ruchira Papers Limited (NSE: RUCHIRA) uses debt in its business. But the real question is whether this debt makes the business risky.
What risk does debt carry?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.
Check out our latest analysis for Ruchira Papers
What is Ruchira Papers net debt?
The image below, which you can click on for more details, shows that Ruchira Papers had debt of ₹626.5 million at the end of September 2021, a reduction from ₹652.9 million year on year. Net debt is about the same, since she doesn’t have a lot of cash.
How strong is Ruchira Papers’ balance sheet?
Zooming in on the latest balance sheet data, we can see that Ruchira Papers had liabilities of ₹1.06 billion due within 12 months and liabilities of ₹519.6 million due beyond. In return, he had ₹8.76 million in cash and ₹822.9 million in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of ₹745.4 million.
This shortfall is not that bad as Ruchira Papers is worth ₹1.82 billion and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. However, it is always worth taking a close look at its ability to repay debt.
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 ).
With net debt of just 1.1x EBITDA, Ruchira Papers is arguably quite conservative. And this view is supported by strong interest coverage, with EBIT amounting to 8.6 times interest expense over the past year. It was also good to see that despite losing money on the EBIT line last year, Ruchira Papers turned it around in the last 12 months, delivering an EBIT of ₹404 million. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in total isolation; since Ruchira Papers 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 business needs free cash flow to pay off its debts; book profits are not enough. It is therefore worth checking how much of earnings before interest and tax (EBIT) is supported by free cash flow. Over the past year, Ruchira Papers has nearly broken even on a free cash flow basis. While many businesses operate at breakeven, we’d rather see substantial free cash flow, especially if it’s already dead.
Our point of view
Ruchira Papers’ EBIT to free cash flow conversion was a real negative in this analysis, although the other factors we considered put it in a much better light. But on the bright side, its ability to cover its interest costs with its EBIT isn’t too shabby at all. Looking at all the angles mentioned above, it seems to us that Ruchira Papers is a somewhat risky investment due to its debt. This isn’t necessarily a bad thing, since leverage can increase return on equity, but it is something to be aware of. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example Ruchira Papers has 4 warning signs (and 1 that doesn’t sit well with us) we think you should be aware of.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.
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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.