K.P.R. Mill (NSE:KPRMILL) Seems To Use Debt Quite Sensibly

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.' 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 note that K.P.R. Mill Limited (NSE:KPRMILL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for K.P.R. Mill

What Is K.P.R. Mill's Net Debt?

The image below, which you can click on for greater detail, shows that K.P.R. Mill had debt of ₹8.43b at the end of September 2023, a reduction from ₹10.6b over a year. However, it does have ₹7.55b in cash offsetting this, leading to net debt of about ₹875.5m.

How Strong Is K.P.R. Mill's Balance Sheet?

The latest balance sheet data shows that K.P.R. Mill had liabilities of ₹6.25b due within a year, and liabilities of ₹5.69b falling due after that. Offsetting these obligations, it had cash of ₹7.55b as well as receivables valued at ₹4.78b due within 12 months. So it actually has ₹400.7m more liquid assets than total liabilities.

Having regard to K.P.R. Mill's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹265.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, K.P.R. Mill has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

K.P.R. Mill has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.071 and EBIT of 15.9 times the interest expense. So relative to past earnings, the debt load seems trivial. But the bad news is that K.P.R. Mill has seen its EBIT plunge 10% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if K.P.R. Mill can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, K.P.R. Mill created free cash flow amounting to 11% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Both K.P.R. Mill's ability to to cover its interest expense with its EBIT and its net debt to EBITDA gave us comfort that it can handle its debt. Having said that, its conversion of EBIT to free cash flow somewhat sensitizes us to potential future risks to the balance sheet. Considering this range of data points, we think K.P.R. Mill is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for K.P.R. Mill that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.