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Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 like to look at its use of debt, since debt overload can lead to ruin. We note that Everest Industries Limited (NSE:EVERESTIND) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Everest Industries
How Much Debt Does Everest Industries Carry?
You can click the graphic below for the historical numbers, but it shows that Everest Industries had ₹627.1m of debt in September 2019, down from ₹899.9m, one year before. On the flip side, it has ₹166.7m in cash leading to net debt of about ₹460.4m.
How Strong Is Everest Industries's Balance Sheet?
According to the last reported balance sheet, Everest Industries had liabilities of ₹3.38b due within 12 months, and liabilities of ₹813.3m due beyond 12 months. Offsetting these obligations, it had cash of ₹166.7m as well as receivables valued at ₹1.02b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹3.00b.
This is a mountain of leverage relative to its market capitalization of ₹4.52b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Everest Industries has a low net debt to EBITDA ratio of only 0.55. And its EBIT easily covers its interest expense, being 25.6 times the size. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Everest Industries's EBIT dived 18%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Everest Industries's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.