Is Radico Khaitan (NSE:RADICO) A Risky Investment?

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. We can see that Radico Khaitan Limited (NSE:RADICO) 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Radico Khaitan

What Is Radico Khaitan's Net Debt?

As you can see below, Radico Khaitan had ₹2.04b of debt at September 2021, down from ₹3.10b a year prior. However, because it has a cash reserve of ₹743.1m, its net debt is less, at about ₹1.29b.

How Healthy Is Radico Khaitan's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Radico Khaitan had liabilities of ₹7.23b due within 12 months and liabilities of ₹989.1m due beyond that. Offsetting these obligations, it had cash of ₹743.1m as well as receivables valued at ₹9.29b due within 12 months. So it actually has ₹1.82b more liquid assets than total liabilities.

Having regard to Radico Khaitan's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹121.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, Radico Khaitan has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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.

Radico Khaitan has a low net debt to EBITDA ratio of only 0.31. And its EBIT easily covers its interest expense, being 5k times the size. So we're pretty relaxed about its super-conservative use of debt. The good news is that Radico Khaitan has increased its EBIT by 8.3% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Radico Khaitan 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Radico Khaitan's free cash flow amounted to 34% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that Radico Khaitan's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. When we consider the range of factors above, it looks like Radico Khaitan is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Radico Khaitan .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.