Butterfly Gandhimathi Appliances (NSE:BUTTERFLY) Seems To Use Debt Rather Sparingly

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. As with many other companies Butterfly Gandhimathi Appliances Limited (NSE:BUTTERFLY) makes use of 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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Butterfly Gandhimathi Appliances

What Is Butterfly Gandhimathi Appliances's Net Debt?

The image below, which you can click on for greater detail, shows that Butterfly Gandhimathi Appliances had debt of ₹810.2m at the end of March 2021, a reduction from ₹1.70b over a year. However, it does have ₹424.1m in cash offsetting this, leading to net debt of about ₹386.1m.

How Strong Is Butterfly Gandhimathi Appliances' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Butterfly Gandhimathi Appliances had liabilities of ₹2.51b due within 12 months and liabilities of ₹138.7m due beyond that. Offsetting these obligations, it had cash of ₹424.1m as well as receivables valued at ₹743.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.48b.

Given Butterfly Gandhimathi Appliances has a market capitalization of ₹14.3b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Looking at its net debt to EBITDA of 0.48 and interest cover of 3.7 times, it seems to us that Butterfly Gandhimathi Appliances is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Pleasingly, Butterfly Gandhimathi Appliances is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 139% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Butterfly Gandhimathi Appliances's earnings that will influence how the balance sheet holds up in the future. 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. Happily for any shareholders, Butterfly Gandhimathi Appliances actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that Butterfly Gandhimathi Appliances's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its interest cover. Looking at the bigger picture, we think Butterfly Gandhimathi Appliances's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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. To that end, you should be aware of the 1 warning sign we've spotted with Butterfly Gandhimathi Appliances .

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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