Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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, Jay Shree Tea & Industries Limited (NSE:JAYSREETEA) does carry debt. But the more important question is: how much risk is that debt creating?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Jay Shree Tea & Industries's Debt?
You can click the graphic below for the historical numbers, but it shows that Jay Shree Tea & Industries had ₹3.17b of debt in September 2021, down from ₹4.38b, one year before. However, it does have ₹299.7m in cash offsetting this, leading to net debt of about ₹2.87b.
A Look At Jay Shree Tea & Industries' Liabilities
Zooming in on the latest balance sheet data, we can see that Jay Shree Tea & Industries had liabilities of ₹5.46b due within 12 months and liabilities of ₹1.40b due beyond that. Offsetting this, it had ₹299.7m in cash and ₹824.9m in receivables that were due within 12 months. So it has liabilities totalling ₹5.73b more than its cash and near-term receivables, combined.
This deficit casts a shadow over the ₹1.97b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Jay Shree Tea & Industries would likely require a major re-capitalisation if it had to pay its creditors today.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Weak interest cover of 0.0039 times and a disturbingly high net debt to EBITDA ratio of 12.1 hit our confidence in Jay Shree Tea & Industries like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Jay Shree Tea & Industries saw its EBIT tank 100% over the last 12 months. 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 Jay Shree Tea & Industries'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last two years, Jay Shree Tea & Industries actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
On the face of it, Jay Shree Tea & Industries's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. After considering the datapoints discussed, we think Jay Shree Tea & Industries has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Jay Shree Tea & Industries has 3 warning signs (and 1 which is a bit concerning) we think you should know about.
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.