Does Orient Paper & Industries (NSE:ORIENTPPR) Have A Healthy Balance Sheet?

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.' 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. We note that Orient Paper & Industries Limited (NSE:ORIENTPPR) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Orient Paper & Industries

What Is Orient Paper & Industries's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2020 Orient Paper & Industries had debt of ₹287.4m, up from ₹212.9m in one year. However, it also had ₹33.0m in cash, and so its net debt is ₹254.4m.

How Healthy Is Orient Paper & Industries's Balance Sheet?

We can see from the most recent balance sheet that Orient Paper & Industries had liabilities of ₹1.82b falling due within a year, and liabilities of ₹2.50b due beyond that. On the other hand, it had cash of ₹33.0m and ₹390.0m worth of receivables due within a year. So its liabilities total ₹3.9b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₹3.94b, so it does suggest shareholders should keep an eye on Orient Paper & 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Orient Paper & Industries's net debt is only 0.52 times its EBITDA. And its EBIT covers its interest expense a whopping 28.7 times over. So we're pretty relaxed about its super-conservative use of debt. It is just as well that Orient Paper & Industries's load is not too heavy, because its EBIT was down 84% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Orient Paper & Industries will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Orient Paper & Industries recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

While Orient Paper & Industries's EBIT growth rate has us nervous. To wit both its interest cover and conversion of EBIT to free cash flow were encouraging signs. We think that Orient Paper & Industries's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider risks, for instance. Every company has them, and we've spotted 3 warning signs for Orient Paper & Industries you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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