We Think Paramount Communications (NSE:PARACABLES) Can Stay On Top Of Its Debt

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. Importantly, Paramount Communications Limited (NSE:PARACABLES) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, 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.

View our latest analysis for Paramount Communications

How Much Debt Does Paramount Communications Carry?

As you can see below, Paramount Communications had ₹1.51b of debt at September 2023, down from ₹1.81b a year prior. However, it also had ₹362.6m in cash, and so its net debt is ₹1.15b.

How Healthy Is Paramount Communications' Balance Sheet?

According to the last reported balance sheet, Paramount Communications had liabilities of ₹2.36b due within 12 months, and liabilities of ₹520.1m due beyond 12 months. Offsetting this, it had ₹362.6m in cash and ₹2.00b in receivables that were due within 12 months. So it has liabilities totalling ₹515.3m more than its cash and near-term receivables, combined.

Since publicly traded Paramount Communications shares are worth a total of ₹20.7b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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).

Paramount Communications's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its commanding EBIT of 19.3 times its interest expense, implies the debt load is as light as a peacock feather. In addition to that, we're happy to report that Paramount Communications has boosted its EBIT by 89%, thus reducing the spectre of future debt repayments. 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 Paramount Communications 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, 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, Paramount Communications saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Happily, Paramount Communications's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. All these things considered, it appears that Paramount Communications can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Paramount Communications has 2 warning signs (and 1 which is significant) we think you should know about.

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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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.