Parsvnath Developers (NSE:PARSVNATH) Takes On Some Risk With Its Use Of Debt

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 Parsvnath Developers Limited (NSE:PARSVNATH) makes use of debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Parsvnath Developers

What Is Parsvnath Developers's Debt?

As you can see below, Parsvnath Developers had ₹23.7b of debt at March 2020, down from ₹42.2b a year prior. However, it also had ₹2.39b in cash, and so its net debt is ₹21.3b.

A Look At Parsvnath Developers's Liabilities

Zooming in on the latest balance sheet data, we can see that Parsvnath Developers had liabilities of ₹50.3b due within 12 months and liabilities of ₹24.5b due beyond that. Offsetting this, it had ₹2.39b in cash and ₹3.05b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹69.3b.

This deficit casts a shadow over the ₹1.41b 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, Parsvnath Developers would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

Parsvnath Developers shareholders face the double whammy of a high net debt to EBITDA ratio (38.0), and fairly weak interest coverage, since EBIT is just 0.06 times the interest expense. The debt burden here is substantial. However, the silver lining was that Parsvnath Developers achieved a positive EBIT of ₹291m in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Parsvnath Developers 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 it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Parsvnath Developers actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

To be frank both Parsvnath Developers's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. We're quite clear that we consider Parsvnath Developers to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Parsvnath Developers (including 1 which is is potentially serious) .

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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