Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Dalmia Bharat Sugar and Industries Limited (NSE:DALMIASUG) does have debt on its balance sheet. 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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Dalmia Bharat Sugar and Industries's Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Dalmia Bharat Sugar and Industries had ₹9.78b of debt, an increase on ₹7.76b, over one year. On the flip side, it has ₹2.77b in cash leading to net debt of about ₹7.01b.
How Strong Is Dalmia Bharat Sugar and Industries's Balance Sheet?
The latest balance sheet data shows that Dalmia Bharat Sugar and Industries had liabilities of ₹10.6b due within a year, and liabilities of ₹6.01b falling due after that. Offsetting this, it had ₹2.77b in cash and ₹2.32b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹11.5b.
This deficit casts a shadow over the ₹7.32b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt At the end of the day, Dalmia Bharat Sugar and Industries would probably need a major re-capitalization if its creditors were to demand repayment.
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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Dalmia Bharat Sugar and Industries's debt is 2.5 times its EBITDA, and its EBIT cover its interest expense 2.9 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. One way Dalmia Bharat Sugar and Industries could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 15%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Dalmia Bharat Sugar and Industries'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Dalmia Bharat Sugar and Industries's free cash flow amounted to 40% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Mulling over Dalmia Bharat Sugar and Industries's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But at least it's pretty decent at growing its EBIT; that's encouraging. Overall, we think it's fair to say that Dalmia Bharat Sugar and Industries has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. Over time, share prices tend to follow earnings per share, so if you're interested in Dalmia Bharat Sugar and Industries, you may well want to click here to check an interactive graph of its earnings per share history.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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