Here's Why Dollar Industries (NSE:DOLLAR) Can Manage Its Debt Responsibly

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.' 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 can see that Dollar Industries Limited (NSE:DOLLAR) 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 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Dollar Industries

What Is Dollar Industries's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Dollar Industries had ₹1.69b of debt, an increase on ₹1.29b, over one year. However, because it has a cash reserve of ₹86.7m, its net debt is less, at about ₹1.60b.

How Strong Is Dollar Industries' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Dollar Industries had liabilities of ₹3.93b due within 12 months and liabilities of ₹81.3m due beyond that. Offsetting this, it had ₹86.7m in cash and ₹3.79b in receivables that were due within 12 months. So its liabilities total ₹133.2m more than the combination of its cash and short-term receivables.

Having regard to Dollar Industries' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹31.4b company is short on cash, but still worth keeping an eye on the balance sheet.

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.

Dollar Industries has a low net debt to EBITDA ratio of only 0.84. And its EBIT covers its interest expense a whopping 32.5 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Dollar Industries has boosted its EBIT by 57%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Dollar Industries will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Dollar Industries recorded free cash flow of 29% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that Dollar Industries's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Zooming out, Dollar Industries seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return 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. Be aware that Dollar Industries is showing 2 warning signs in our investment analysis , you should know about...

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.