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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Balaji Amines Limited (NSE:BALAMINES) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.
See our latest analysis for Balaji Amines
What Is Balaji Amines's Net Debt?
As you can see below, at the end of March 2019, Balaji Amines had ₹2.28b of debt, up from ₹1.52b a year ago. Click the image for more detail. On the flip side, it has ₹144.8m in cash leading to net debt of about ₹2.13b.
A Look At Balaji Amines's Liabilities
We can see from the most recent balance sheet that Balaji Amines had liabilities of ₹3.08b falling due within a year, and liabilities of ₹1.45b due beyond that. Offsetting these obligations, it had cash of ₹144.8m as well as receivables valued at ₹2.25b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹2.14b.
While this might seem like a lot, it is not so bad since Balaji Amines has a market capitalization of ₹10.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Balaji Amines has a low net debt to EBITDA ratio of only 1.1. And its EBIT easily covers its interest expense, being 16.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Balaji Amines grew its EBIT by 5.7% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is Balaji Amines'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.