We Think Aditya Birla Fashion and Retail (NSE:ABFRL) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Aditya Birla Fashion and Retail Limited (NSE:ABFRL) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Aditya Birla Fashion and Retail

What Is Aditya Birla Fashion and Retail's Net Debt?

As you can see below, Aditya Birla Fashion and Retail had ₹13.3b of debt at September 2021, down from ₹33.4b a year prior. However, because it has a cash reserve of ₹4.57b, its net debt is less, at about ₹8.73b.

A Look At Aditya Birla Fashion and Retail's Liabilities

Zooming in on the latest balance sheet data, we can see that Aditya Birla Fashion and Retail had liabilities of ₹48.3b due within 12 months and liabilities of ₹37.5b due beyond that. Offsetting these obligations, it had cash of ₹4.57b as well as receivables valued at ₹10.2b due within 12 months. So its liabilities total ₹71.1b more than the combination of its cash and short-term receivables.

Aditya Birla Fashion and Retail has a market capitalization of ₹261.4b, 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 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Aditya Birla Fashion and Retail's debt to EBITDA ratio (3.6) suggests that it uses some debt, its interest cover is very weak, at 0.051, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. However, the silver lining was that Aditya Birla Fashion and Retail achieved a positive EBIT of ₹199m in the last twelve months, an improvement on the prior year's loss. 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Aditya Birla Fashion and Retail actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Aditya Birla Fashion and Retail's interest cover was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its conversion of EBIT to free cash flow. Looking at all this data makes us feel a little cautious about Aditya Birla Fashion and Retail's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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.

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.