Avenue Supermarts (NSE:DMART) Has A Pretty Healthy 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.' 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. As with many other companies Avenue Supermarts Limited (NSE:DMART) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Avenue Supermarts

What Is Avenue Supermarts's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Avenue Supermarts had ₹6.47b of debt, an increase on ₹3.93b, over one year. However, because it has a cash reserve of ₹3.05b, its net debt is less, at about ₹3.42b.

How Healthy Is Avenue Supermarts' Balance Sheet?

According to the last reported balance sheet, Avenue Supermarts had liabilities of ₹12.2b due within 12 months, and liabilities of ₹5.76b due beyond 12 months. On the other hand, it had cash of ₹3.05b and ₹673.5m worth of receivables due within a year. So its liabilities total ₹14.2b more than the combination of its cash and short-term receivables.

Having regard to Avenue Supermarts' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹2.90t company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, Avenue Supermarts has a very light debt load indeed.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

Avenue Supermarts's net debt is only 0.10 times its EBITDA. And its EBIT easily covers its interest expense, being 45.7 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Avenue Supermarts has boosted its EBIT by 92%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Avenue Supermarts can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Avenue Supermarts burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Avenue Supermarts's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Taking all this data into account, it seems to us that Avenue Supermarts takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Avenue Supermarts , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.