Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The biggest 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. Like many other companies VIP Industries Limited (NSE:VIPIND) uses debt. But does this debt worry shareholders?
When is debt dangerous?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, 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 at a low price, thereby permanently diluting shareholders. 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 and debt together.
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What is the debt of VIP Industries?
You can click on the graph below for historical figures, but it shows that VIP Industries had ₹2.98 billion in debt in March 2022, up from ₹3.53 billion a year before. However, he has ₹579.8 million in cash to offset this, resulting in a net debt of around ₹2.40 billion.
How healthy is VIP Industries’ balance sheet?
According to the latest published balance sheet, VIP Industries had liabilities of ₹5.17 billion due within 12 months and liabilities of ₹1.54 billion due beyond 12 months. In return, he had ₹579.8 million in cash and ₹2.19 billion in receivables due within 12 months. Thus, its liabilities total ₹3.93 billion more than the combination of its cash and short-term receivables.
Considering that VIP Industries has a market capitalization of ₹87.5 billion, it is hard to believe that these liabilities pose a big threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate.
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). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
VIP Industries’ net debt is only 1.3 times its EBITDA. And its EBIT covers its interest charges 11.2 times. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Although VIP Industries recorded a loss in EBIT last year, it was also good to see that it generated ₹1.7 billion in EBIT in the last twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether VIP Industries can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore important to check how much of its earnings before interest and taxes (EBIT) converts into actual free cash flow. Over the past year, VIP Industries has experienced substantial negative free cash flow, overall. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
The conversion of EBIT to free cash flow by VIP Industries was a real negative in this analysis, even though the other factors we considered were considerably better. There is no doubt that its ability to cover its interest costs with its EBIT is quite flashy. When we consider all the factors mentioned above, we feel a bit cautious about VIP Industries’ use of debt. While debt has its upside in higher potential returns, we think shareholders should certainly consider how debt levels could make the stock more risky. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example, VIP Industries has 3 warning signs (and 1 which is potentially serious) that we think you should know about.
If you are interested in investing in companies 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.
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