L.G. Balakrishnan & Bros (NSE:LGBBROSLTD) Takes On Some Risk With Its Use Of Debt

Simply Wall St

Thu, Oct 31, 2019, 8:21 PM

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies L.G. Balakrishnan & Bros Limited (NSE:LGBBROSLTD) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for L.G. Balakrishnan & Bros

How Much Debt Does L.G. Balakrishnan & Bros Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2019 L.G. Balakrishnan & Bros had ₹2.18b of debt, an increase on ₹1.08b, over one year. However, it does have ₹86.2m in cash offsetting this, leading to net debt of about ₹2.09b.

NSEI:LGBBROSLTD Historical Debt, November 1st 2019

A Look At L.G. Balakrishnan & Bros's Liabilities

According to the last reported balance sheet, L.G. Balakrishnan & Bros had liabilities of ₹4.10b due within 12 months, and liabilities of ₹1.30b due beyond 12 months. On the other hand, it had cash of ₹86.2m and ₹2.33b worth of receivables due within a year. So its liabilities total ₹2.99b more than the combination of its cash and short-term receivables.

L.G. Balakrishnan & Bros has a market capitalization of ₹8.90b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

L.G. Balakrishnan & Bros has a low net debt to EBITDA ratio of only 1.1. And its EBIT covers its interest expense a whopping 10.6 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that L.G. Balakrishnan & Bros saw its EBIT decline by 7.2% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine L.G. Balakrishnan & Bros'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Considering the last three years, L.G. Balakrishnan & Bros actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for and improvement.

Our View

L.G. Balakrishnan & Bros's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its interest cover was re-invigorating. Taking the abovementioned factors together we do think L.G. Balakrishnan & Bros's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. Given our hesitation about the stock, it would be good to know if L.G. Balakrishnan & Bros insiders have sold any shares recently. You click here to find out if insiders have sold recently.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.

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