Here's Why Orbit Exports (NSE:ORBTEXP) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 note that Orbit Exports Limited (NSE:ORBTEXP) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Orbit Exports

How Much Debt Does Orbit Exports Carry?

The image below, which you can click on for greater detail, shows that Orbit Exports had debt of ₹388.6m at the end of September 2023, a reduction from ₹468.5m over a year. On the flip side, it has ₹198.0m in cash leading to net debt of about ₹190.7m.

A Look At Orbit Exports' Liabilities

According to the last reported balance sheet, Orbit Exports had liabilities of ₹375.1m due within 12 months, and liabilities of ₹362.8m due beyond 12 months. Offsetting this, it had ₹198.0m in cash and ₹420.3m in receivables that were due within 12 months. So its liabilities total ₹119.6m more than the combination of its cash and short-term receivables.

Of course, Orbit Exports has a market capitalization of ₹4.17b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Orbit Exports's net debt is only 0.36 times its EBITDA. And its EBIT easily covers its interest expense, being 28.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that Orbit Exports saw its EBIT decline by 3.7% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Orbit Exports 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Orbit Exports recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Happily, Orbit Exports's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its EBIT growth rate. Looking at all the aforementioned factors together, it strikes us that Orbit Exports can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. For example, we've discovered 1 warning sign for Orbit Exports that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.