Is Bombay Burmah Trading Corporation (NSE:BBTC) A Risky Investment?

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.' 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 The Bombay Burmah Trading Corporation, Limited (NSE:BBTC) 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Bombay Burmah Trading Corporation

What Is Bombay Burmah Trading Corporation's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Bombay Burmah Trading Corporation had debt of ₹48.0b, up from ₹29.7b in one year. On the flip side, it has ₹41.2b in cash leading to net debt of about ₹6.80b.

A Look At Bombay Burmah Trading Corporation's Liabilities

According to the last reported balance sheet, Bombay Burmah Trading Corporation had liabilities of ₹51.0b due within 12 months, and liabilities of ₹24.5b due beyond 12 months. Offsetting this, it had ₹41.2b in cash and ₹12.9b in receivables that were due within 12 months. So it has liabilities totalling ₹21.4b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Bombay Burmah Trading Corporation is worth ₹71.0b, 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Bombay Burmah Trading Corporation's net debt is only 0.27 times its EBITDA. And its EBIT easily covers its interest expense, being 12.2 times the size. So we're pretty relaxed about its super-conservative use of debt. But the other side of the story is that Bombay Burmah Trading Corporation saw its EBIT decline by 2.1% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is Bombay Burmah Trading Corporation'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 we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Bombay Burmah Trading Corporation recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Both Bombay Burmah Trading Corporation's ability to to cover its interest expense with its EBIT and its net debt to EBITDA gave us comfort that it can handle its debt. Having said that, its EBIT growth rate somewhat sensitizes us to potential future risks to the balance sheet. When we consider all the elements mentioned above, it seems to us that Bombay Burmah Trading Corporation is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Bombay Burmah Trading Corporation you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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.

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