Does Remsons Industries (NSE:REMSONSIND) Have A Healthy Balance Sheet?
The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Remsons Industries Limited (NSE:REMSONSIND) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Remsons Industries
What Is Remsons Industries's Net Debt?
The image below, which you can click on for greater detail, shows that Remsons Industries had debt of ₹263.3m at the end of March 2019, a reduction from ₹286.6m over a year. On the flip side, it has ₹6.09m in cash leading to net debt of about ₹257.2m.
How Healthy Is Remsons Industries's Balance Sheet?
We can see from the most recent balance sheet that Remsons Industries had liabilities of ₹497.3m falling due within a year, and liabilities of ₹87.4m due beyond that. Offsetting this, it had ₹6.09m in cash and ₹268.4m in receivables that were due within 12 months. So it has liabilities totalling ₹310.2m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of ₹485.6m, so it does suggest shareholders should keep an eye on Remsons Industries's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).
Remsons Industries's debt is 2.9 times its EBITDA, and its EBIT cover its interest expense 2.8 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. More concerning, Remsons Industries saw its EBIT drop by 5.4% in the last twelve months. If that earnings trend continues the company will face an uphill battle to pay off its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Remsons Industries will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent two years, Remsons Industries recorded free cash flow of 43% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Our View
Mulling over Remsons Industries's attempt at covering its interest expense with its EBIT, we're certainly not enthusiastic. But at least its conversion of EBIT to free cash flow is not so bad. Once we consider all the factors above, together, it seems to us that Remsons Industries's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Remsons Industries's earnings per share history for free.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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