Is VIP Clothing (NSE:VIPCLOTHNG) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 VIP Clothing Limited (NSE:VIPCLOTHNG) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for VIP Clothing

What Is VIP Clothing's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 VIP Clothing had ₹844.3m of debt, an increase on ₹788.0m, over one year. However, it does have ₹79.3m in cash offsetting this, leading to net debt of about ₹764.9m.

A Look At VIP Clothing's Liabilities

According to the last reported balance sheet, VIP Clothing had liabilities of ₹1.13b due within 12 months, and liabilities of ₹224.9m due beyond 12 months. Offsetting this, it had ₹79.3m in cash and ₹605.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹666.5m.

This deficit isn't so bad because VIP Clothing is worth ₹1.60b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. 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.

VIP Clothing shareholders face the double whammy of a high net debt to EBITDA ratio (15.2), and fairly weak interest coverage, since EBIT is just 0.10 times the interest expense. This means we'd consider it to have a heavy debt load. One redeeming factor for VIP Clothing is that it turned last year's EBIT loss into a gain of ₹11m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is VIP Clothing'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, VIP Clothing actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

VIP Clothing's interest cover and net debt to EBITDA definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that VIP Clothing is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. Be aware that VIP Clothing is showing 3 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

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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This article by Simply Wall St is general in nature. 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.
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