We Think Peria Karamalai Tea and Produce (NSE:PKTEA) Is Taking Some Risk With Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that The Peria Karamalai Tea and Produce Company Limited (NSE:PKTEA) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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 Peria Karamalai Tea and Produce

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

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Peria Karamalai Tea and Produce had ₹232.3m of debt, an increase on ₹196.8m, over one year. However, it also had ₹122.0m in cash, and so its net debt is ₹110.2m.

How Healthy 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 ₹263.9m due within 12 months and liabilities of ₹116.5m due beyond that. Offsetting this, it had ₹122.0m in cash and ₹284.8m in receivables that were due within 12 months. So it can boast ₹26.3m more liquid assets than total liabilities.

This surplus suggests that Peria Karamalai Tea and Produce has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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.

Even though Peria Karamalai Tea and Produce's debt is only 2.2, its interest cover is really very low at 1.3. This does suggest the company is paying fairly high interest rates. Either way there's no doubt the stock is using meaningful leverage. Notably, Peria Karamalai Tea and Produce made a loss at the EBIT level, last year, but improved that to positive EBIT of ₹27m in the last twelve months. 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 Peria Karamalai Tea and Produce 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 company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, 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

Both Peria Karamalai Tea and Produce's conversion of EBIT to free cash flow and its interest cover were discouraging. At least its level of total liabilities gives us reason to be optimistic. Taking the abovementioned factors together we do think Peria Karamalai Tea and Produce's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. To that end, you should learn about the 2 warning signs we've spotted with Peria Karamalai Tea and Produce (including 1 which is a bit concerning) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.