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

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.' 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 can see that McLeod Russel India Limited (NSE:MCLEODRUSS) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for McLeod Russel India

What Is McLeod Russel India's Net Debt?

The image below, which you can click on for greater detail, shows that McLeod Russel India had debt of ₹20.2b at the end of March 2021, a reduction from ₹21.3b over a year. However, it does have ₹987.9m in cash offsetting this, leading to net debt of about ₹19.2b.

How Healthy Is McLeod Russel India's Balance Sheet?

According to the last reported balance sheet, McLeod Russel India had liabilities of ₹28.2b due within 12 months, and liabilities of ₹2.62b due beyond 12 months. Offsetting this, it had ₹987.9m in cash and ₹566.7m in receivables that were due within 12 months. So its liabilities total ₹29.3b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the ₹3.20b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, McLeod Russel India would probably need a major re-capitalization if its creditors were to demand repayment.

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.

Weak interest cover of 0.62 times and a disturbingly high net debt to EBITDA ratio of 9.0 hit our confidence in McLeod Russel India like a one-two punch to the gut. 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is McLeod Russel India'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, while the tax-man may adore accounting profits, lenders only accept 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. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

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 on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for McLeod Russel India you should be aware of, and 1 of them 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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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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