La Opala RG (NSE:LAOPALA) Could Easily Take On More Debt

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. We can see that La Opala RG Limited (NSE:LAOPALA) 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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for La Opala RG

How Much Debt Does La Opala RG Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 La Opala RG had ₹134.9m of debt, an increase on ₹5.21m, over one year. But it also has ₹3.08b in cash to offset that, meaning it has ₹2.95b net cash.

A Look At La Opala RG's Liabilities

Zooming in on the latest balance sheet data, we can see that La Opala RG had liabilities of ₹716.0m due within 12 months and liabilities of ₹395.4m due beyond that. Offsetting these obligations, it had cash of ₹3.08b as well as receivables valued at ₹514.2m due within 12 months. So it actually has ₹2.48b more liquid assets than total liabilities.

This short term liquidity is a sign that La Opala RG could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that La Opala RG has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, La Opala RG grew its EBIT by 121% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 La Opala RG 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 company can only pay off debt with cold hard cash, not accounting profits. While La Opala RG has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, La Opala RG recorded free cash flow of 43% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that La Opala RG has net cash of ₹2.95b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 121% over the last year. So we don't think La Opala RG's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for La Opala RG 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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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.