Beardsell (NSE:BEARDSELL) Seems To Use Debt Quite Sensibly

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.' 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. As with many other companies Beardsell Limited (NSE:BEARDSELL) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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 Beardsell

What Is Beardsell's Debt?

The image below, which you can click on for greater detail, shows that Beardsell had debt of ₹258.0m at the end of March 2022, a reduction from ₹340.1m over a year. However, it also had ₹25.5m in cash, and so its net debt is ₹232.5m.

How Healthy Is Beardsell's Balance Sheet?

We can see from the most recent balance sheet that Beardsell had liabilities of ₹669.9m falling due within a year, and liabilities of ₹99.9m due beyond that. Offsetting this, it had ₹25.5m in cash and ₹355.5m in receivables that were due within 12 months. So its liabilities total ₹388.8m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₹633.2m, so it does suggest shareholders should keep an eye on Beardsell's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Beardsell has a quite reasonable net debt to EBITDA multiple of 1.9, its interest cover seems weak, at 1.3. In large part that's it has so much depreciation and amortisation. These charges may be non-cash, so they could be excluded when it comes to paying down debt. But the accounting charges are there for a reason -- some assets are seen to be losing value. Either way there's no doubt the stock is using meaningful leverage. Also relevant is that Beardsell has grown its EBIT by a very respectable 22% in the last year, thus enhancing its ability to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Beardsell'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. 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, Beardsell actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Beardsell's interest cover was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. Considering this range of data points, we think Beardsell is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Beardsell is showing 6 warning signs in our investment analysis , and 3 of those don't sit too well with us...

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.