Here's Why Vikas Multicorp (NSE:VIKASMCORP) Is Weighed Down By Its Debt Load

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.' 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. As with many other companies Vikas Multicorp Limited (NSE:VIKASMCORP) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Vikas Multicorp

How Much Debt Does Vikas Multicorp Carry?

As you can see below, Vikas Multicorp had ₹405.5m of debt, at March 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has ₹9.12m in cash leading to net debt of about ₹396.4m.

How Healthy Is Vikas Multicorp's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Vikas Multicorp had liabilities of ₹1.91b due within 12 months and liabilities of ₹106.6m due beyond that. Offsetting this, it had ₹9.12m in cash and ₹1.18b in receivables that were due within 12 months. So it has liabilities totalling ₹824.4m more than its cash and near-term receivables, combined.

Of course, Vikas Multicorp has a market capitalization of ₹5.41b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.78 times and a disturbingly high net debt to EBITDA ratio of 8.7 hit our confidence in Vikas Multicorp like a one-two punch to the gut. The debt burden here is substantial. Worse, Vikas Multicorp's EBIT was down 26% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Vikas Multicorp 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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, Vikas Multicorp saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Vikas Multicorp's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least its level of total liabilities is not so bad. We're quite clear that we consider Vikas Multicorp to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Case in point: We've spotted 3 warning signs for Vikas Multicorp you should be aware of, and 1 of them makes us a bit uncomfortable.

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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