Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We can see that Bharat Rasayan Limited (NSE: BHARATRAS) uses debt in its business. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
See our latest analysis for Bharat Rasayan
How many debts does Bharat Rasayan carry?
As you can see below, at the end of March 2022, Bharat Rasayan had a debt of ₹1.74 billion, up from ₹584.5 million a year ago. Click on the image for more details. However, since he has a cash reserve of ₹62.8 million, his net debt is lower at around ₹1.67 billion.
A look at the responsibilities of Bharat Rasayan
The latest balance sheet data shows that Bharat Rasayan had liabilities of ₹3.09 billion due within a year, and liabilities of ₹111.4 million falling due thereafter. On the other hand, it had a cash position of ₹62.8 million and ₹4.68 billion in receivables due within a year. It can therefore boast of having ₹1.54 billion in liquid assets more than total Passives.
This surplus suggests that Bharat Rasayan has a conservative balance sheet, and could probably eliminate its debt without too much difficulty.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without depreciation and amortization charges.
Bharat Rasayan’s net debt is only 0.66 times its EBITDA. And its EBIT covers its interest charges 33.8 times. So we’re pretty relaxed about his super conservative use of debt. The good news is that Bharat Rasayan increased its EBIT by 6.8% year-over-year, which should ease any worries about its debt repayment. The balance sheet is clearly the area to focus on when analyzing debt. But it is Bharat Rasayan’s earnings that will influence the balance sheet going forward. So, if you want to know more about its earnings, it might be worth checking out this graph of its long-term trend.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Bharat Rasayan’s free cash flow has been 34% of its EBIT, less than we expected. This low cash conversion makes debt management more difficult.
Our point of view
Fortunately, Bharat Rasayan’s impressive interest coverage means he has the upper hand on his debt. But truth be told, we think his conversion of EBIT to free cash flow somewhat undermines that impression. Given all this data, it seems to us that Bharat Rasayan is taking a pretty sensible approach to debt. This means they take on a bit more risk, hoping to increase shareholder returns. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, Bharat Rasayan has 3 warning signs (and 1 that can’t be ignored) that we think you should know about.
If you are interested in investing in businesses that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.