Stock Analysis

Is Megastar Foods (NSE:MEGASTAR) Using Too Much Debt?

NSEI:MEGASTAR
Source: Shutterstock

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Megastar Foods Limited (NSE:MEGASTAR) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Megastar Foods

What Is Megastar Foods's Debt?

As you can see below, at the end of September 2024, Megastar Foods had ₹1.79b of debt, up from ₹809.8m a year ago. Click the image for more detail. And it doesn't have much cash, so its net debt is about the same.

debt-equity-history-analysis
NSEI:MEGASTAR Debt to Equity History January 29th 2025

How Healthy Is Megastar Foods' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Megastar Foods had liabilities of ₹1.63b due within 12 months and liabilities of ₹512.5m due beyond that. Offsetting this, it had ₹12.6m in cash and ₹419.6m in receivables that were due within 12 months. So its liabilities total ₹1.71b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of ₹2.61b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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

Megastar Foods shareholders face the double whammy of a high net debt to EBITDA ratio (14.0), and fairly weak interest coverage, since EBIT is just 2.4 times the interest expense. The debt burden here is substantial. Even worse, Megastar Foods saw its EBIT tank 49% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Megastar Foods 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.

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 three years, Megastar Foods saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Megastar Foods's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And furthermore, its interest cover also fails to instill confidence. After considering the datapoints discussed, we think Megastar Foods has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Megastar Foods (including 2 which can't be ignored) .

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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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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:MEGASTAR

Megastar Foods

Engages in the bulk food processing and producing a range of wholesome wheat flour products in India.

Low with questionable track record.

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