Is Relaxo Footwears (NSE:RELAXO) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Relaxo Footwears Limited (NSE:RELAXO) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Relaxo Footwears

What Is Relaxo Footwears's Debt?

The image below, which you can click on for greater detail, shows that Relaxo Footwears had debt of ₹291.7m at the end of September 2020, a reduction from ₹2.31b over a year. But it also has ₹2.76b in cash to offset that, meaning it has ₹2.46b net cash.

How Healthy Is Relaxo Footwears' Balance Sheet?

According to the last reported balance sheet, Relaxo Footwears had liabilities of ₹4.18b due within 12 months, and liabilities of ₹1.56b due beyond 12 months. On the other hand, it had cash of ₹2.76b and ₹1.50b worth of receivables due within a year. So it has liabilities totalling ₹1.48b more than its cash and near-term receivables, combined.

Having regard to Relaxo Footwears' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹208.0b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Relaxo Footwears also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, Relaxo Footwears grew its EBIT by 2.6% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But it is Relaxo Footwears'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Relaxo Footwears may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Relaxo Footwears produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

We could understand if investors are concerned about Relaxo Footwears's liabilities, but we can be reassured by the fact it has has net cash of ₹2.46b. So is Relaxo Footwears's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 1 warning sign for Relaxo Footwears 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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