Here's Why Monte Carlo Fashions (NSE:MONTECARLO) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Monte Carlo Fashions Limited (NSE:MONTECARLO) does carry debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Monte Carlo Fashions

How Much Debt Does Monte Carlo Fashions Carry?

You can click the graphic below for the historical numbers, but it shows that Monte Carlo Fashions had ₹820.5m of debt in September 2020, down from ₹1.78b, one year before. However, because it has a cash reserve of ₹768.0m, its net debt is less, at about ₹52.5m.

How Strong Is Monte Carlo Fashions's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Monte Carlo Fashions had liabilities of ₹2.99b due within 12 months and liabilities of ₹1.06b due beyond that. On the other hand, it had cash of ₹768.0m and ₹1.95b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹1.34b.

Monte Carlo Fashions has a market capitalization of ₹5.01b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. But either way, Monte Carlo Fashions 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Monte Carlo Fashions's net debt to EBITDA ratio is very low, at 0.056, suggesting the debt is only trivial. But EBIT was only 6.3 times the interest expense last year, so the borrowing is clearly weighing on the business somewhat. On the other hand, Monte Carlo Fashions's EBIT dived 12%, over the last year. 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 you can't view debt in total isolation; since Monte Carlo Fashions 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Monte Carlo Fashions recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

On our analysis Monte Carlo Fashions's net debt to EBITDA should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For example, its EBIT growth rate makes us a little nervous about its debt. When we consider all the elements mentioned above, it seems to us that Monte Carlo Fashions is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. Take risks, for example - Monte Carlo Fashions has 3 warning signs we think you should be aware of.

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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