Stock Analysis

Is Radico Khaitan (NSE:RADICO) Using Too Much Debt?

NSEI:RADICO
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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 note that Radico Khaitan Limited (NSE:RADICO) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Radico Khaitan

What Is Radico Khaitan's Debt?

The image below, which you can click on for greater detail, shows that Radico Khaitan had debt of ₹2.63b at the end of March 2021, a reduction from ₹4.00b over a year. On the flip side, it has ₹1.30b in cash leading to net debt of about ₹1.33b.

debt-equity-history-analysis
NSEI:RADICO Debt to Equity History June 24th 2021

How Healthy Is Radico Khaitan's Balance Sheet?

According to the last reported balance sheet, Radico Khaitan had liabilities of ₹8.19b due within 12 months, and liabilities of ₹1.02b due beyond 12 months. Offsetting these obligations, it had cash of ₹1.30b as well as receivables valued at ₹7.73b due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Radico Khaitan's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹106.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, Radico Khaitan has a very light debt load indeed.

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.

Radico Khaitan has a low net debt to EBITDA ratio of only 0.33. And its EBIT easily covers its interest expense, being 16.1 times the size. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Radico Khaitan grew its EBIT by 12% last year, making its debt load easier to handle. 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 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 49% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Radico Khaitan's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Zooming out, Radico Khaitan seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Radico Khaitan has 2 warning signs we think you should be aware of.

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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