These 4 Measures Indicate That Aditya Birla Fashion and Retail (NSE:ABFRL) Is Using Debt Reasonably Well

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Aditya Birla Fashion and Retail Limited (NSE:ABFRL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Aditya Birla Fashion and Retail

What Is Aditya Birla Fashion and Retail's Debt?

As you can see below, at the end of March 2023, Aditya Birla Fashion and Retail had ₹23.1b of debt, up from ₹12.3b a year ago. Click the image for more detail. However, because it has a cash reserve of ₹8.83b, its net debt is less, at about ₹14.2b.

How Strong Is Aditya Birla Fashion and Retail's Balance Sheet?

The latest balance sheet data shows that Aditya Birla Fashion and Retail had liabilities of ₹70.9b due within a year, and liabilities of ₹66.1b falling due after that. On the other hand, it had cash of ₹8.83b and ₹9.68b worth of receivables due within a year. So its liabilities total ₹118.4b more than the combination of its cash and short-term receivables.

Aditya Birla Fashion and Retail has a market capitalization of ₹210.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Given net debt is only 0.95 times EBITDA, it is initially surprising to see that Aditya Birla Fashion and Retail's EBIT has low interest coverage of 0.56 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Pleasingly, Aditya Birla Fashion and Retail is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 138% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Aditya Birla Fashion and Retail can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last two years, Aditya Birla Fashion and Retail actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Aditya Birla Fashion and Retail's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its interest cover. Looking at all the aforementioned factors together, it strikes us that Aditya Birla Fashion and Retail can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. While Aditya Birla Fashion and Retail didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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.