Is Orient Bell (NSE:ORIENTBELL) Using Too Much Debt?

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.' 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. Importantly, Orient Bell Limited (NSE:ORIENTBELL) does carry debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

See our latest analysis for Orient Bell

What Is Orient Bell's Debt?

As you can see below, Orient Bell had ₹359.7m of debt at September 2020, down from ₹606.2m a year prior. However, it does have ₹337.1m in cash offsetting this, leading to net debt of about ₹22.6m.

How Strong Is Orient Bell's Balance Sheet?

The latest balance sheet data shows that Orient Bell had liabilities of ₹1.01b due within a year, and liabilities of ₹661.1m falling due after that. Offsetting this, it had ₹337.1m in cash and ₹678.2m in receivables that were due within 12 months. So it has liabilities totalling ₹658.2m more than its cash and near-term receivables, combined.

Given Orient Bell has a market capitalization of ₹3.49b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, Orient Bell has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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.

Orient Bell has a very low debt to EBITDA ratio of 0.11 so it is strange to see weak interest coverage, with last year's EBIT being only 0.043 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Shareholders should be aware that Orient Bell's EBIT was down 98% 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 Orient Bell 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Orient Bell 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

We weren't impressed with Orient Bell's interest cover, and its EBIT growth rate made us cautious. But its conversion of EBIT to free cash flow was significantly redeeming. When we consider all the factors mentioned above, we do feel a bit cautious about Orient Bell's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. For instance, we've identified 4 warning signs for Orient Bell (1 makes us a bit uncomfortable) you should be aware of.

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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