These 4 Measures Indicate That Monte Carlo Fashions (NSE:MONTECARLO) Is Using Debt Reasonably Well

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Monte Carlo Fashions Limited (NSE:MONTECARLO) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

Check out our latest analysis for Monte Carlo Fashions

How Much Debt Does Monte Carlo Fashions Carry?

You can click the graphic below for the historical numbers, but it shows that Monte Carlo Fashions had ₹317.5m of debt in March 2020, down from ₹446.1m, one year before. But it also has ₹1.11b in cash to offset that, meaning it has ₹789.5m net cash.

How Strong Is Monte Carlo Fashions's Balance Sheet?

According to the last reported balance sheet, Monte Carlo Fashions had liabilities of ₹2.59b due within 12 months, and liabilities of ₹1.07b due beyond 12 months. Offsetting this, it had ₹1.11b in cash and ₹2.57b in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Monte Carlo Fashions's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹3.49b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Monte Carlo Fashions has more cash than debt is arguably a good indication that it can manage its debt safely.

Importantly Monte Carlo Fashions's EBIT was essentially flat over the last twelve months. We would prefer to see some earnings growth, because that always helps diminish debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Monte Carlo Fashions'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Monte Carlo Fashions 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, Monte Carlo Fashions recorded free cash flow worth 51% 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.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Monte Carlo Fashions has net cash of ₹789.5m, as well as more liquid assets than liabilities. So we are not troubled with Monte Carlo Fashions's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Monte Carlo Fashions .

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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