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.' 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. We can see that TCNS Clothing Co. Limited (NSE:TCNSBRANDS) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is TCNS Clothing's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 TCNS Clothing had ₹357.1m of debt, an increase on none, over one year. But it also has ₹1.46b in cash to offset that, meaning it has ₹1.10b net cash.
A Look At TCNS Clothing's Liabilities
According to the last reported balance sheet, TCNS Clothing had liabilities of ₹2.17b due within 12 months, and liabilities of ₹2.96b due beyond 12 months. On the other hand, it had cash of ₹1.46b and ₹1.64b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹2.03b.
Since publicly traded TCNS Clothing shares are worth a total of ₹25.1b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, TCNS Clothing also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if TCNS Clothing can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Over 12 months, TCNS Clothing made a loss at the EBIT level, and saw its revenue drop to ₹7.2b, which is a fall of 39%. To be frank that doesn't bode well.
So How Risky Is TCNS Clothing?
While TCNS Clothing lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow ₹395m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for TCNS Clothing that you should be aware of before investing here.
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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