Here's Why Som Distilleries & Breweries (NSE:SDBL) Can Manage Its Debt Responsibly

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.' 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 Som Distilleries & Breweries Limited (NSE:SDBL) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Som Distilleries & Breweries

How Much Debt Does Som Distilleries & Breweries Carry?

As you can see below, Som Distilleries & Breweries had ₹1.27b of debt at September 2024, down from ₹1.59b a year prior. However, because it has a cash reserve of ₹213.5m, its net debt is less, at about ₹1.06b.

How Healthy Is Som Distilleries & Breweries' Balance Sheet?

According to the last reported balance sheet, Som Distilleries & Breweries had liabilities of ₹3.78b due within 12 months, and liabilities of ₹1.03b due beyond 12 months. Offsetting these obligations, it had cash of ₹213.5m as well as receivables valued at ₹2.16b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹2.44b.

Of course, Som Distilleries & Breweries has a market capitalization of ₹24.9b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

Som Distilleries & Breweries's net debt is only 0.59 times its EBITDA. And its EBIT easily covers its interest expense, being 28.3 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Som Distilleries & Breweries has boosted its EBIT by 30%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Som Distilleries & Breweries 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, Som Distilleries & Breweries actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Som Distilleries & Breweries's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Som Distilleries & Breweries can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Som Distilleries & Breweries insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.