These 4 Measures Indicate That Genus Paper & Boards (NSE:GENUSPAPER) Is Using Debt Extensively

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. 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 Genus Paper & Boards Limited (NSE:GENUSPAPER) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Genus Paper & Boards

What Is Genus Paper & Boards's Net Debt?

As you can see below, Genus Paper & Boards had ₹572.1m 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 ₹49.6m in cash leading to net debt of about ₹522.6m.

A Look At Genus Paper & Boards's Liabilities

Zooming in on the latest balance sheet data, we can see that Genus Paper & Boards had liabilities of ₹856.6m due within 12 months and liabilities of ₹214.2m due beyond that. On the other hand, it had cash of ₹49.6m and ₹578.8m worth of receivables due within a year. So it has liabilities totalling ₹442.4m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Genus Paper & Boards has a market capitalization of ₹1.30b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Genus Paper & Boards's net debt is sitting at a very reasonable 1.9 times its EBITDA, while its EBIT covered its interest expense just 2.6 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. The bad news is that Genus Paper & Boards saw its EBIT decline by 19% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. When analysing debt levels, the balance sheet is the obvious place to start. But it is Genus Paper & Boards's earnings that will influence how the balance sheet holds up in the future. 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. Happily for any shareholders, Genus Paper & Boards actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Genus Paper & Boards's EBIT growth rate and interest cover definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Looking at all the angles mentioned above, it does seem to us that Genus Paper & Boards is a somewhat risky investment as a result of its debt. 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. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Genus Paper & Boards has 2 warning signs we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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