These 4 Measures Indicate That Oricon Enterprises (NSE:ORICONENT) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Oricon Enterprises Limited (NSE:ORICONENT) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Oricon Enterprises

What Is Oricon Enterprises's Debt?

You can click the graphic below for the historical numbers, but it shows that Oricon Enterprises had ₹2.64b of debt in March 2020, down from ₹4.95b, one year before. However, because it has a cash reserve of ₹1.40b, its net debt is less, at about ₹1.24b.

How Healthy Is Oricon Enterprises's Balance Sheet?

According to the last reported balance sheet, Oricon Enterprises had liabilities of ₹3.45b due within 12 months, and liabilities of ₹1.31b due beyond 12 months. Offsetting these obligations, it had cash of ₹1.40b as well as receivables valued at ₹2.05b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.3b.

While this might seem like a lot, it is not so bad since Oricon Enterprises has a market capitalization of ₹2.70b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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).

Given net debt is only 1.3 times EBITDA, it is initially surprising to see that Oricon Enterprises's EBIT has low interest coverage of 0.39 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Shareholders should be aware that Oricon Enterprises's EBIT was down 85% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Oricon Enterprises 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 it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Oricon Enterprises 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

Neither Oricon Enterprises's ability to grow its EBIT nor its interest cover gave us confidence in its ability to take on more debt. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Oricon Enterprises's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. To that end, you should be aware of the 3 warning signs we've spotted with Oricon Enterprises .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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