Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Century Enka Limited (NSE:CENTENKA) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
What Is Century Enka's Net Debt?
As you can see below, Century Enka had ₹119.6m of debt at September 2020, down from ₹253.8m a year prior. However, it does have ₹3.03b in cash offsetting this, leading to net cash of ₹2.91b.
A Look At Century Enka's Liabilities
Zooming in on the latest balance sheet data, we can see that Century Enka had liabilities of ₹740.7m due within 12 months and liabilities of ₹1.10b due beyond that. Offsetting this, it had ₹3.03b in cash and ₹1.49b in receivables that were due within 12 months. So it can boast ₹2.67b more liquid assets than total liabilities.
This surplus strongly suggests that Century Enka has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Simply put, the fact that Century Enka has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Century Enka 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.
Over 12 months, Century Enka made a loss at the EBIT level, and saw its revenue drop to ₹11b, which is a fall of 32%. To be frank that doesn't bode well.
So How Risky Is Century Enka?
Although Century Enka had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of ₹209m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. There's no doubt the next few years will be crucial to how the business matures. 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, we've discovered 3 warning signs for Century Enka that you should be aware of before investing here.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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This article by Simply Wall St is general in nature. 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.
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