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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies KRBL Limited (NSE:KRBL) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.
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What Is KRBL's Debt?
The image below, which you can click on for greater detail, shows that KRBL had debt of ₹893.9m at the end of March 2022, a reduction from ₹3.08b over a year. But on the other hand it also has ₹4.12b in cash, leading to a ₹3.22b net cash position.
How Healthy Is KRBL's Balance Sheet?
According to the last reported balance sheet, KRBL had liabilities of ₹4.87b due within 12 months, and liabilities of ₹1.90b due beyond 12 months. Offsetting this, it had ₹4.12b in cash and ₹2.89b in receivables that were due within 12 months. So it can boast ₹243.3m more liquid assets than total liabilities.
Having regard to KRBL's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₹55.7b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, KRBL boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that KRBL's load is not too heavy, because its EBIT was down 22% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since KRBL will need earnings to service that debt. 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. KRBL may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, KRBL recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
Summing up
While it is always sensible to investigate a company's debt, in this case KRBL has ₹3.22b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₹5.2b, being 95% of its EBIT. So we are not troubled with KRBL's debt use. We'd be motivated to research the stock further if we found out that KRBL insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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.
About NSEI:KRBL
KRBL
Manufactures and markets rice products in India and internationally.
Flawless balance sheet average dividend payer.