V.I.P. Industries (NSE:VIPIND) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, V.I.P. Industries Limited (NSE:VIPIND) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for V.I.P. Industries

What Is V.I.P. Industries's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 V.I.P. Industries had ₹1.81b of debt, an increase on ₹1.23b, over one year. However, it also had ₹589.5m in cash, and so its net debt is ₹1.22b.

How Healthy Is V.I.P. Industries' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that V.I.P. Industries had liabilities of ₹6.26b due within 12 months and liabilities of ₹1.48b due beyond that. On the other hand, it had cash of ₹589.5m and ₹2.55b worth of receivables due within a year. So it has liabilities totalling ₹4.59b more than its cash and near-term receivables, combined.

Given V.I.P. Industries has a market capitalization of ₹92.6b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. But either way, V.I.P. Industries has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With net debt sitting at just 0.39 times EBITDA, V.I.P. Industries is arguably pretty conservatively geared. And it boasts interest cover of 8.4 times, which is more than adequate. Better yet, V.I.P. Industries grew its EBIT by 210% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine V.I.P. Industries's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last two years, V.I.P. Industries created free cash flow amounting to 2.5% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

The good news is that V.I.P. Industries's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. When we consider the range of factors above, it looks like V.I.P. Industries is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. We've identified 1 warning sign with V.I.P. Industries , and understanding them should be part of your investment process.

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. 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.