Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We note that Parsvnath Developers Limited (NSE:PARSVNATH) has debt on its balance sheet. But does this debt worry shareholders?
What risk does debt carry?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
Check out our latest analysis for Parsvnath Developers
What is Parsvnath Developers net debt?
You can click on the graph below for historical figures, but it shows that as of September 2021, Parsvnath developers had ₹36.4 billion in debt, an increase from ₹30.1 billion, on a year. On the other hand, he has ₹1.05 billion in cash, resulting in a net debt of around ₹35.4 billion.
A Look at the Responsibilities of Parsvnath Developers
According to the latest published balance sheet, Parsvnath Developers had liabilities of ₹52.0 billion due within 12 months and liabilities of ₹26.0 billion due beyond 12 months. As compensation for these obligations, it had cash of ₹1.05 billion as well as receivables valued at ₹2.91 billion due within 12 months. Thus, its liabilities total ₹74.1 billion more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the ₹7.18 billion society, like a colossus towering above mere mortals. So we definitely think shareholders need to watch this one closely. Ultimately, Parsvnath Developers would likely need a major recapitalization if its creditors were to demand repayment.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Low interest coverage of 0.11x and an extremely high net debt to EBITDA ratio of 54.6 shook our confidence in Parsvnath Developers like a punch in the gut. This means that we would consider him to be heavily indebted. Worse still, Parsvnath Developers has seen its EBIT soar to 26% over the past 12 months. If profits continue like this in the long term, there is an unimaginable chance of repaying this debt. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; since Parsvnath Developers will need revenue to repay this debt. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Finally, while the taxman may love accounting profits, lenders only accept cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past two years, Parsvnath Developers has actually produced more free cash flow than EBIT. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our point of view
To be frank, Parsvnath Developers’ EBIT growth rate and track record of keeping total liabilities under control makes us rather uncomfortable with its level of leverage. But on the bright side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Considering all the above factors, it seems that Parsvnath Developers has too much debt. That kind of risk is acceptable to some, but it certainly doesn’t float our boat. 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 Parsvnath Developers has 3 warning signs (and 1 which is significant) that we think you should know about.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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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.