McLeod Russel India (NSE:MCLEODRUSS) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that McLeod Russel India Limited (NSE:MCLEODRUSS) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for McLeod Russel India

How Much Debt Does McLeod Russel India Carry?

The image below, which you can click on for greater detail, shows that McLeod Russel India had debt of ₹21.1b at the end of September 2020, a reduction from ₹22.9b over a year. However, it also had ₹950.6m in cash, and so its net debt is ₹20.1b.

A Look At McLeod Russel India's Liabilities

According to the last reported balance sheet, McLeod Russel India had liabilities of ₹29.6b due within 12 months, and liabilities of ₹3.40b due beyond 12 months. On the other hand, it had cash of ₹950.6m and ₹1.48b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹30.5b.

This deficit casts a shadow over the ₹2.35b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, McLeod Russel India would likely require a major re-capitalisation if it had to pay its creditors today.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

McLeod Russel India shareholders face the double whammy of a high net debt to EBITDA ratio (10.8), and fairly weak interest coverage, since EBIT is just 0.63 times the interest expense. This means we'd consider it to have a heavy debt load. One redeeming factor for McLeod Russel India is that it turned last year's EBIT loss into a gain of ₹1.2b, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is McLeod Russel India'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 it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, McLeod Russel India 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.

Our View

To be frank both McLeod Russel India's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. We're quite clear that we consider McLeod Russel India 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. 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. To that end, you should learn about the 2 warning signs we've spotted with McLeod Russel India (including 1 which is a bit concerning) .

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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