Here's Why Globe Textiles (India) (NSE:GLOBE) Has A Meaningful Debt Burden

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.' 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. Importantly, Globe Textiles (India) Limited (NSE:GLOBE) does carry debt. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Globe Textiles (India)

What Is Globe Textiles (India)'s Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Globe Textiles (India) had debt of ₹623.8m, up from ₹503.7m in one year. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is Globe Textiles (India)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Globe Textiles (India) had liabilities of ₹1.36b due within 12 months and liabilities of ₹34.3m due beyond that. Offsetting this, it had ₹1.22m in cash and ₹914.8m in receivables that were due within 12 months. So its liabilities total ₹480.3m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₹620.7m, so it does suggest shareholders should keep an eye on Globe Textiles (India)'s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.75 times and a disturbingly high net debt to EBITDA ratio of 12.0 hit our confidence in Globe Textiles (India) like a one-two punch to the gut. The debt burden here is substantial. Even worse, Globe Textiles (India) saw its EBIT tank 59% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Globe Textiles (India)'s earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Globe Textiles (India) produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

To be frank both Globe Textiles (India)'s interest cover and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. We're quite clear that we consider Globe Textiles (India) to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 Globe Textiles (India) 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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