Silgo Retail (NSE:SILGO) Has A Somewhat Strained Balance Sheet

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Silgo Retail Limited (NSE:SILGO) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Silgo Retail

How Much Debt Does Silgo Retail Carry?

As you can see below, at the end of September 2022, Silgo Retail had ₹198.6m of debt, up from ₹171.6m a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.

A Look At Silgo Retail's Liabilities

The latest balance sheet data shows that Silgo Retail had liabilities of ₹197.8m due within a year, and liabilities of ₹39.2m falling due after that. On the other hand, it had cash of ₹375.7k and ₹84.9m worth of receivables due within a year. So its liabilities total ₹151.7m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Silgo Retail has a market capitalization of ₹261.9m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Silgo Retail's debt is 4.0 times its EBITDA, and its EBIT cover its interest expense 3.0 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. On a slightly more positive note, Silgo Retail grew its EBIT at 12% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Silgo Retail 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Silgo Retail burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We'd go so far as to say Silgo Retail's conversion of EBIT to free cash flow was disappointing. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Silgo Retail's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Silgo Retail (2 make us uncomfortable!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.