Does Aditya Birla Fashion and Retail (NSE:ABFRL) Have A Healthy Balance Sheet?

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.' 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. We note that Aditya Birla Fashion and Retail Limited (NSE:ABFRL) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Aditya Birla Fashion and Retail

How Much Debt Does Aditya Birla Fashion and Retail Carry?

The chart below, which you can click on for greater detail, shows that Aditya Birla Fashion and Retail had ₹13.7b in debt in September 2022; about the same as the year before. However, it also had ₹11.3b in cash, and so its net debt is ₹2.43b.

A Look At Aditya Birla Fashion and Retail's Liabilities

The latest balance sheet data shows that Aditya Birla Fashion and Retail had liabilities of ₹77.5b due within a year, and liabilities of ₹41.0b falling due after that. Offsetting these obligations, it had cash of ₹11.3b as well as receivables valued at ₹11.8b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹95.4b.

This deficit isn't so bad because Aditya Birla Fashion and Retail is worth ₹294.1b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Carrying virtually no net debt, Aditya Birla Fashion and Retail has a very light debt load indeed.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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 0.20 times EBITDA, it is initially surprising to see that Aditya Birla Fashion and Retail's EBIT has low interest coverage of 2.5 times. So one way or the other, it's clear the debt levels are not trivial. Pleasingly, Aditya Birla Fashion and Retail is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 4,380% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Aditya Birla Fashion and Retail's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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. Happily for any shareholders, Aditya Birla Fashion and Retail actually produced more free cash flow than EBIT over the last two 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

The good news is that Aditya Birla Fashion and Retail's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its interest cover. Looking at the bigger picture, we think Aditya Birla Fashion and Retail's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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. We've identified 1 warning sign with Aditya Birla Fashion and Retail , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.