Is Loyal Textile Mills (NSE:LOYALTEX) Using Too Much 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Loyal Textile Mills Limited (NSE:LOYALTEX) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View 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 Loyal Textile Mills had debt of ₹4.73b at the end of September 2024, a reduction from ₹6.57b over a year. However, because it has a cash reserve of ₹100.6m, its net debt is less, at about ₹4.63b.

How Strong Is Loyal Textile Mills' Balance Sheet?

The latest balance sheet data shows that Loyal Textile Mills had liabilities of ₹6.18b due within a year, and liabilities of ₹22.8m falling due after that. Offsetting this, it had ₹100.6m in cash and ₹1.20b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹4.91b.

The deficiency here weighs heavily on the ₹1.55b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Loyal Textile Mills would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. 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 32%, to ₹7.9b. To be frank that doesn't bode well.

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). Indeed, it lost a very considerable ₹1.1b at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of ₹799m in the last year. So while it's not wise to assume the company will fail, we do think it's risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Loyal Textile Mills (of which 2 shouldn't be ignored!) you should know about.

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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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.