These 4 Measures Indicate That Peria Karamalai Tea and Produce (NSE:PKTEA) Is Using Debt Reasonably Well

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. As with many other companies The Peria Karamalai Tea and Produce Company Limited (NSE:PKTEA) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Peria Karamalai Tea and Produce

What Is Peria Karamalai Tea and Produce's Net Debt?

As you can see below, Peria Karamalai Tea and Produce had ₹210.6m of debt at September 2024, down from ₹231.7m a year prior. On the flip side, it has ₹27.9m in cash leading to net debt of about ₹182.7m.

How Strong Is Peria Karamalai Tea and Produce's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Peria Karamalai Tea and Produce had liabilities of ₹256.0m due within 12 months and liabilities of ₹112.3m due beyond that. On the other hand, it had cash of ₹27.9m and ₹86.2m worth of receivables due within a year. So it has liabilities totalling ₹254.2m more than its cash and near-term receivables, combined.

Since publicly traded Peria Karamalai Tea and Produce shares are worth a total of ₹2.41b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Looking at its net debt to EBITDA of 1.5 and interest cover of 4.3 times, it seems to us that Peria Karamalai Tea and Produce is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Pleasingly, Peria Karamalai Tea and Produce is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 430% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Peria Karamalai Tea and Produce will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last two years, Peria Karamalai Tea and Produce burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Peria Karamalai Tea and Produce's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to grow its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about Peria Karamalai Tea and Produce's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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 4 warning signs we've spotted with Peria Karamalai Tea and Produce (including 1 which makes us a bit uncomfortable) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.