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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Indo Count Industries Limited (NSE:ICIL) does carry debt. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. 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 examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Indo Count Industries Carry?
You can click the graphic below for the historical numbers, but it shows that Indo Count Industries had ₹2.85b of debt in September 2020, down from ₹5.19b, one year before. However, because it has a cash reserve of ₹2.49b, its net debt is less, at about ₹357.2m.
How Strong Is Indo Count Industries' Balance Sheet?
The latest balance sheet data shows that Indo Count Industries had liabilities of ₹4.93b due within a year, and liabilities of ₹1.19b falling due after that. Offsetting this, it had ₹2.49b in cash and ₹3.41b in receivables that were due within 12 months. So it has liabilities totalling ₹218.4m more than its cash and near-term receivables, combined.
Having regard to Indo Count Industries' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹27.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, Indo Count Industries has a very light debt load indeed.
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.
Indo Count Industries's net debt is only 0.14 times its EBITDA. And its EBIT easily covers its interest expense, being 14.8 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Indo Count Industries grew its EBIT by 7.5% in the last year, making that debt load look even more manageable. 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 Indo Count Industries 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Indo Count Industries recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
The good news is that Indo Count Industries's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Overall, we don't think Indo Count Industries is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Indo Count Industries you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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