Warren Buffett famously said, “Volatility is not synonymous with risk.” So, given how risky certain stocks are, it’s clear that debt needs to be considered, as too much debt can sink a company.Like many other companies Nandan Denim Limited (NSE:NDL) uses debt. But the bigger question is how much risk does that liability create?
What are the risks of borrowing?
Debt supports a business until it struggles to pay it back with either new capital or free cash flow. It is a process of “creative destruction”. Although less common, we often see debt companies permanently diluting their shareholders. But by displacing dilution, debt can be a very good tool for companies that need capital to invest in growth at a high rate of return. The first step is to consider cash and debt together.
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How much is Nandan Denim’s debt?
You can click on the chart below for historical figures, which show that Nandan Denim was £5.29bn in debt in September 2022. A year ago he is down from £6.1bn. However, offsetting this, he has cash of Rs 390.8 crore and a net debt of Rs 4.9 crore.
Let’s take a look at Nandan Denim’s debt
Zooming in on the latest balance sheet data, we see that Nandan Denim has a debt of Rs 6.23 crore within 12 months and a debt of Rs 2.41 crore since then. Offsetting these debts was Rs 390.8 crore cash and his receivables Rs 5.05 crore to be paid within 12 months. As such, he is £3.2bn more in debt than his combined cash and short-term receivables.
This deficit is sizable compared to its £3.37 billion market capitalization, suggesting that shareholders should be careful with Nandan Denim’s use of debt. Shareholders could face severe dilution if lenders demand a stronger balance sheet.
To size a company’s liabilities relative to its revenues, divide net debt by earnings before interest, taxes, depreciation and amortization (EBITDA), and divide earnings before interest and taxes (EBIT) by interest expense. (its interest cover). The advantage of this approach is that it takes into account both the absolute amount of debt (net debt to EBITDA) and the actual interest expense associated with that debt (its interest coverage ratio).
Nandan Denim’s debt is 3.3 times EBITDA and EBIT covers 2.8 times interest expense. This suggests that debt levels are fairly high, but not necessarily problematic. Even more worrying is that Nandan Denim’s EBIT has fallen 9.2% over the past 12 months. If it continues like this, paying off debt will be like running on a treadmill. Clearly, the balance sheet is the starting point when analyzing debt levels. However, it is Nandan Denim’s earnings that will affect how the balance sheet will hold up in the future. Therefore, it is worth looking at earnings trends when looking at liabilities. Click here for interactive snapshots.
Finally, tax officials may adore accounting benefits, but lenders only accept cold cash. A logical step, therefore, is to look at the percentage of her EBIT that matches the actual free cash flow. In the last two years, Nandan Denim posted free cash flow equivalent to his 53% of his EBIT. This is about normal when you consider free cash flow, excluding interest and taxes. This free cash flow allows the company to repay its debt if it needs to.
On the surface, Nandan Denim’s total debt levels were tentative for its share price, and its interest cover was less attractive than one empty restaurant on the busiest night of the year. But at least converting EBIT to free cash flow is pretty good. It’s encouraging. All in all, it’s safe to say that Nandan Denim has ample debt and a real risk to its balance sheet. If all goes well, returns should be boosted, but conversely, debt increases the risk of permanent capital loss. Arguably, we learn the most about debt from the balance sheet. However, not all investment risks are on the balance sheet, far from it.Note that Nandan denim is shown 4 warning signs in investment analysis and two of them make us uncomfortable…
After all, it is often better to focus on companies with no net debt. Access a special list of such companies (all with a track record of profit growth). It’s free.
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This article by Simply Wall St is general in nature. We provide comments based on historical data and analyst projections using only unbiased methodologies and our articles are not intended as financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. We aim to deliver long-term focused analysis based on fundamental data. Please note that our analysis may not take into account the latest price sensitive company announcements or qualitative materials. Is not …