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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. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, The Grob Tea Company Limited (NSE:GROBTEA) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Grob Tea
How Much Debt Does Grob Tea Carry?
The image below, which you can click on for greater detail, shows that at March 2019 Grob Tea had debt of ₹64.1m, up from ₹44.6m in one year. On the flip side, it has ₹52.7m in cash leading to net debt of about ₹11.3m.
How Healthy Is Grob Tea's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Grob Tea had liabilities of ₹221.1m due within 12 months and liabilities of ₹29.8m due beyond that. Offsetting this, it had ₹52.7m in cash and ₹67.1m in receivables that were due within 12 months. So it has liabilities totalling ₹131.0m more than its cash and near-term receivables, combined.
This deficit isn't so bad because Grob Tea is worth ₹329.4m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Grob Tea's net debt is only 0.19 times its EBITDA. And its EBIT covers its interest expense a whopping 33.2 times over. So we're pretty relaxed about its super-conservative use of debt. On top of that, Grob Tea grew its EBIT by 75% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Grob Tea's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.