Harrisons Malayalam (NSE:HARRMALAYA) Use Of Debt Could Be Considered Risky

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Harrisons Malayalam Limited (NSE:HARRMALAYA) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Harrisons Malayalam

What Is Harrisons Malayalam's Debt?

As you can see below, at the end of March 2023, Harrisons Malayalam had ₹954.8m of debt, up from ₹887.7m a year ago. Click the image for more detail. However, it does have ₹20.5m in cash offsetting this, leading to net debt of about ₹934.3m.

A Look At Harrisons Malayalam's Liabilities

Zooming in on the latest balance sheet data, we can see that Harrisons Malayalam had liabilities of ₹1.89b due within 12 months and liabilities of ₹1.00b due beyond that. Offsetting this, it had ₹20.5m in cash and ₹116.9m in receivables that were due within 12 months. So its liabilities total ₹2.75b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₹2.86b, so it does suggest shareholders should keep an eye on Harrisons Malayalam's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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).

While we wouldn't worry about Harrisons Malayalam's net debt to EBITDA ratio of 4.8, we think its super-low interest cover of 1.2 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Worse, Harrisons Malayalam's EBIT was down 50% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Harrisons Malayalam's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Harrisons Malayalam's free cash flow amounted to 44% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, Harrisons Malayalam's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least its conversion of EBIT to free cash flow is not so bad. We're quite clear that we consider Harrisons Malayalam to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. For instance, we've identified 3 warning signs for Harrisons Malayalam (1 can't be ignored) you should be aware of.

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.