Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Polyplex Corporation Limited (NSE:POLYPLEX) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Polyplex's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2019 Polyplex had ₹7.85b of debt, an increase on ₹7.39b, over one year. But on the other hand it also has ₹7.92b in cash, leading to a ₹65.9m net cash position.
How Healthy Is Polyplex's Balance Sheet?
According to the last reported balance sheet, Polyplex had liabilities of ₹9.40b due within 12 months, and liabilities of ₹2.58b due beyond 12 months. Offsetting this, it had ₹7.92b in cash and ₹6.56b in receivables that were due within 12 months. So it actually has ₹2.50b more liquid assets than total liabilities.
This surplus suggests that Polyplex is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Polyplex boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Polyplex has boosted its EBIT by 48%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Polyplex's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Polyplex has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Polyplex recorded free cash flow worth 55% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While we empathize with investors who find debt concerning, you should keep in mind that Polyplex has net cash of ₹66m, as well as more liquid assets than liabilities. And we liked the look of last year's 48% year-on-year EBIT growth. So is Polyplex's debt a risk? It doesn't seem so to us. Given Polyplex has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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