Is Loyal Textile Mills (NSE:LOYALTEX) Using Debt 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 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. We can see that Loyal Textile Mills Limited (NSE:LOYALTEX) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Loyal Textile Mills

How Much Debt Does Loyal Textile Mills Carry?

The image below, which you can click on for greater detail, shows that at December 2023 Loyal Textile Mills had debt of ₹6.34b, up from ₹3.53b in one year. However, it does have ₹160.2m in cash offsetting this, leading to net debt of about ₹6.18b.

A Look At Loyal Textile Mills' Liabilities

According to the last reported balance sheet, Loyal Textile Mills had liabilities of ₹8.55b due within 12 months, and liabilities of ₹13.0m due beyond 12 months. Offsetting these obligations, it had cash of ₹160.2m as well as receivables valued at ₹1.88b due within 12 months. So it has liabilities totalling ₹6.52b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₹2.66b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Loyal Textile Mills would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Loyal Textile Mills'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.

In the last year Loyal Textile Mills had a loss before interest and tax, and actually shrunk its revenue by 31%, to ₹11b. That makes us nervous, to say the least.

Caveat Emptor

Not only did Loyal Textile Mills's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping ₹637m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through ₹49m in negative free cash flow over the last year. That means it's on the risky side of things. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Loyal Textile Mills is showing 4 warning signs in our investment analysis , and 3 of those make us uncomfortable...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.