David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies B.L. Kashyap and Sons Limited (NSE:BLKASHYAP) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does B.L. Kashyap and Sons Carry?
The chart below, which you can click on for greater detail, shows that B.L. Kashyap and Sons had ₹4.46b in debt in September 2020; about the same as the year before. However, because it has a cash reserve of ₹272.2m, its net debt is less, at about ₹4.19b.
A Look At B.L. Kashyap and Sons' Liabilities
The latest balance sheet data shows that B.L. Kashyap and Sons had liabilities of ₹9.40b due within a year, and liabilities of ₹3.89b falling due after that. On the other hand, it had cash of ₹272.2m and ₹6.51b worth of receivables due within a year. So it has liabilities totalling ₹6.52b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the ₹2.39b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, B.L. Kashyap and Sons would likely require a major re-capitalisation if it had to pay its creditors today.
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).
Weak interest cover of 0.31 times and a disturbingly high net debt to EBITDA ratio of 17.7 hit our confidence in B.L. Kashyap and Sons like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, B.L. Kashyap and Sons's EBIT was down 22% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since B.L. Kashyap and Sons 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, B.L. Kashyap and Sons actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
To be frank both B.L. Kashyap and Sons's EBIT growth rate 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. After considering the datapoints discussed, we think B.L. Kashyap and Sons has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that B.L. Kashyap and Sons is showing 4 warning signs in our investment analysis , and 2 of those are potentially serious...
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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